ERICOPOLY

Years ago they cut tax rate to zero for Muni bonds when they wanted the Muni interest rates to drop. They could make borrowing cheaper in other sectors if they went that route. The Fed buying bonds in an attempt to drop rates seems like a clumsier way of dropping mortgage rates than just cutting taxes on mortgage interest. I wonder how far rates would fall if the lenders didn't have to pay tax on the interest? Paying back 1/3 of your income in taxes is just as painful as not collecting interest from 1/3 of your borrowers. Perhaps it would spur lending as you could take on more risk if you didn't have to worry about losing 1/3 of the income to the government.

Australia has expanded for 20 years now without contraction. What is the record? Six years sounds like a lot unless you've already seen 20.

No, wait! I can agree with Packer that the bull market might go on for yet another while… but don’t tell me it has just started… please, look at the chart! It is 5 years now the market has gone nowhere but up… Isn’t that a good enough definition of a bull market? ;) giofranchi Well, you don’t want to make things too complicated, do you? … What you have written is what happens during “secular bear markets” … But do you really want to talk about that? If you do and care (but I am not sure!), 2009 as the end of the "secular bear market" is simply inconsistent with history, meaning what can be observed about “secular bear markets” of the past: 1) Inconsistent with the mean duration of “secular bear markets”: 9 years instead of 17 years. 2) Inconsistent with market valuations: in 2009 market valuations were still much higher than they were at other “secular bear market” bottoms. 3) Inconsistent with logic: in 2000 valuations were the highest ever reached, and the secular bull market just ending was one of the longest lived. Why then should we expect a shorter and a more benign “secular bear market”, instead of a longer and a tougher one? giofranchi Falling from the 5th floor of a building onto concrete ought to hurt more than falling from the 2nd floor onto concrete. Perhaps though, falling from the 5th floor of a building into a safety net doesn't hurt more than falling from a 2nd floor onto concrete. (we forgot to mention the policy responses)

Hey wait a minute. There is no limit to how many 529 plans that are set up for you -- the only limit is that people can't make further contributions once your combined beneficiary total amounts to $300k account balance. So if my mother also set up an account for myself and an account for my wife, we could also contribute $140,000 to each of those plans. So on day one (without triggering gift taxes), each of us could be funded for $280,000 (combined $560,000). That's near enough to hitting the individual $300k limit that I'd consider it a success. Then there is my mother-in-law too -- we could have her setup accounts for us and just put the remaining 20k each into those accounts. So that's the entire 600k joint limit fully accounted for, clear of potential gift tax problems. Although I still could be wrong about that -- I'm not sure if the gift tax limit is considered for each account owner, or if it's just for the beneficiary. If it were for the account owner, then it would only be 140k for my father, 140k for my mother, and 140k for my mother-in-law. That's only 420 total. Hmm...

The part that I'm pretty sure about is that you don't pay the 10% penalty on non-qualified withdrawals if the account was inherited. However, the gains in the account are still taxed as income. But in my case I don't have a regular IRA -- only a Roth IRA. So if I accumulate some gains in a 529 plan and pull out a little bit each year, the tax rate will be low assuming I do this late in life when I have no other source of taxable income (like when I'm just drawing from the 529 plan and my RothIRA as my only remaining liquid funds).. When I converted my IRA to RothIRA I did 100% of the entire account -- I figured I might go back to work one day and contribute again to an IRA. But this 529 plan is perhaps the "IRA" now. Then again, I don't have to spend it on myself. If I wind up having grandkids, I can always assign it to their 529 accounts. And if I don't, my kids could always inherit mine. Or once they've gone to college and significantly drawn down their own plans, I could then gift a portion of my account to their account each year. Hmmm... so much to think about. But one of the things I'm not at all certain of is whether I can fund the account with the entire $300,000 right away without triggering gift taxes -- I believe I would be able to since I would in a way be just giving the money to myself (I'm the beneficiary). But then again, he's the owner and as owner of the account he could change the beneficiary to himself I suppose, which would be a weird way of me funding his education account without gift taxes. So I'm not sure. But I'm fairly sure that I could fund it with at least $140k right away -- my wife and I can each put in $14,000 a year without triggering any gift taxes, and you are allowed to put in the first 5 years on day one. So $14,000 each going into this account per year for 5 years, meaning I could put $140k into it on day one. Plus, we could also set up an account for my wife to inherit. That's another $140,000 minimum on day one. Together, $280,000 on day one. Potentially, we could be looking at $600,000 on day one with both accounts combined (not sure about that gift tax situation).

Okay, now I'm thinking clearer... Step 1) have my father establish a Vanguard 529 account for me. He is the account owner, I am the "student" beneficiary Step 2) establish myself as the "successor owner" of the account in the event of his death Step 3) I fund the account with $300,000 maximum right away (I believe I'm allowed to contribute that account without triggering gift taxes because I'm the beneficiary. But I'm not certain about that -- it's just what I believe to be true. So it's invested tax-deferred, and when he passes I can then leave the funds in there throughout my lifetime. Anything I spend the money on will not incur the 10% penalty, because I inherited the account (the exemption is for inherited accounts). There, that sounds like a pretty good plan.

Yes. However, it's my after-tax account intrinsic value that matters to me. So whether or not buyback itself adds intrinsic value isn't the final answer -- what also matters is if it doesn't destroy as much intrinsic value for the account as taxable dividends do.

Why are vices criminalized? This is ridiculous IMO. It's funny -- in Australia prostitution is legal but hard core pornography is not. They have a nice clean society. Here, we make prostitution illegal and it's not like it goes away anyhow. So if the goal is to get rid of prostitution we should obviously rethink that, because it's not going away.

They might change the rules, yes. But until that happens I can pick up some tax-deferred compounding. And you know, maybe when the rules change it looks like this: "You cannot make any new contributions to tax-deferred vehicles if you already have a combined balance in excess of $1 million". So, maybe you get as much as you can as fast as you can into such plans. Too hard to say. But it seems unlikely that paying taxes every year on bond income is a better plan.

Regarding the trading limitations. I know, that one trade per year thing stinks. But I figure I can put on offsetting hedges in my taxable account when the market is high. The cost of the hedges will be a tax write-off. So the investments are in the tax-advantaged accounts, and the hedges are in the taxable account. I'm basically just figuring on borrowing the funds from my portfolio margin account, hedging the loan with puts, and depositing the loan in the 529 plan. Thus I generate these tax losses that won't really be losses (offset by gains in the 529 plan). And since I won't be trading the 529 plan, wash sale rules won't apply. Once the puts expire, I will have some losses to offset some gains for selling down my BAC position (and that pays down the margin loan). I want to eventually get a big cushion of money in some less volatile stuff for my sanity -- but things like bonds are a non-starter for tax reasons unless I can do it tax-deferred. Also, does anyone know if creditors can raid 529 plans?

I know they are all limited with investment choices. However I figure they still have a place in my overall planning. For example, that can be a place where I make my super-safe bond investments. The emergency "do not break glass unless severe Depression hits" cash can go there. It stands a chance of maintaining it's purchasing power given the bond income is tax-deferred. You are almost certainly going to lose purchasing power in a high tax bracket invested in bond funds. I wanted to do something like this with variable annuities but the annual expenses are too high. Here, they are not.

I know about the contribution limit, but there is a grey area I'm unsure about with regards to inheritance. Is it treated as a contribution when somebody inherits a 529 plan? So if you establish a $300,000 plan for yourself and it grows to $600,000 over ten years... can your child inherit your $600,000 plan? Or would he be limited to only a $300,000 inheritance? Or would he be able to inherit none of it if he already had over $300,000 in his existing plan? Plus I believe when you inherit a 529 plan you can spend the gains on whatever you choose without that 10% penalty for non-qualified withdrawals. And I believe you can leave the money in there for the rest of your life without being forced to draw it down early. Compare that to inheriting an IRA plan where you are forced to liquidate it within the first 5 years (not sure if it's 5 years exactly, but it's a pretty quick forced withdrawal period). Roth IRAs also (as of now) have no forced withdrawal timeline. Also, does anyone know if creditors can raid 529 plans?

For the following comments lets assume it's in a tax-deferred account (no dividend tax): I'm going to write about how much value is created if instead dividends were paid and reinvested in the stock through a DRIP. Of course, if you get paid a dividend when the price of stock is very low... you wind up with more buying power for additional shares. And when you get paid a dividend when the price of stock is very high... you wind up with less buying power for relatively fewer additional shares. So an observer would notice that the total effect on the portfolio is that more additional shares are purchased if dividends were paid when the stock was low versus when it was high priced. Thus, more value was created. So is management no less shrewd to return capital via dividend when stock price is low? Again, assuming no taxes. The moral of this post is that it simply matters that capital is returned, by either method, as vigorously as possible when the stock price is low. Neither method creates more value than the other. But when taxes come into play, it's better to return capital via share repurchase. But what about when stock price is high and stays high for a decade? Should management not return any capital at all by either method? I think they should return capital by the method that results in the least amount of tax. The guy can destroy just as much value by plowing the dividend into more shares as compared to management buying back shares. The shareholders needs to be personally responsible -- if he can decide when not to buy more shares, he can also decide to sell the incremental fractional ownership that management keeps on buying on his behalf. The higher the dividend tax rate, the more difficult it is for management to make the "wrong" decision by repurchasing shares. The shares need to be overvalued by 50% too high above fair value before we even get to the break-even tipping point when the dividend tax rate is 33%.

A couple of things I noticed tonight about 529 accounts which compound tax-deferred. 1) you can set up a 529 plan for yourself as beneficiary, no matter how old you are (for your future education) 2) later you can transfer the funds to another beneficiary's 529 plan (like in 30 years when you have grandchildren, you transfer it to their 529s) 3) withdrawals for qualified education expenses are completely tax free 4) non-qualified withdrawals are usually assessed a 10% penalty and gains in the account are taxed as income 5) there are exceptions to #4. Such as if the original beneficiary had died, and you inherit the account, then withdrawals can be made without the 10% penalty -- but I think the person inheriting the 529 has no requirement of withdrawing the money, unlike the recipient of an IRA account. Also if the beneficiary becomes permanently disabled (under IRS definition) he can take non-qualified withdrawals penalty free. Another thing I noticed is that annual fund expenses in a Vanguard 529 account are generally 40 bps lower than annual expenses in a Vanguard variable annuity. Over 30 years that amounts to 12% of extra expenses in the annuity -- which is actually greater than the 10% non-qualified withdrawal penalty in the 529 plan. So I had a quiet thought -- if you are going to lock up the money for 30 years or so, it might be cheaper to put it into a 529 plan even if you never intend to use it for education -- I mean, compared to the costs of a variable annuity invested for 30 years, the 10% penalty seems relatively cheaper. Plus, if you die during that period your heirs can take the gains without the 10% penalty -- so it's cheaper than the variable annuity no matter what (as long as you intend to not spend it for 30 years or your death, whichever comes sooner).

In the USA, the qualified dividend rate is the same as the long term cap gains rate. All of my comments pertain to the USA if there was any confusion. Any place where your cap gains rate is higher than your dividend rate (like Warren Buffett at Berkshire) you can take the other side. So that guy is no worse off if he chooses to sell tiny amounts in lieu of a dividend. And he's better off if he wants it reinvested (tax free reinvestment). And being an old guy, his heirs probably want that as well given that it will all be stepped-up in cost basis upon his death. They can either sell his shares (getting all those reinvested buybacks tax-free), or they can choose to keep the shares and start selling pieces to offset buybacks -- with the cap gains paid at the new stepped-up cost basis. I guess that's right, but there is no cost to get the dividends whereas he has to pay commissions to sell bit by bit. I think ultimately the biggest reason to pay the dividends is to broaden the investor base. What is the advantage of broadening the investor base? You are certainly not the first person I've heard talk about that, but it's never something that I've ever quite understood why it's so important.. There are some admired companies like MKL and Berkshire that have a great shareholder base -- but they don't pay dividends. What would improve if they attracted dividend investors? Alright, if somebody says it would boost the share price, I could always say that it would only help the investors who are cashing out and not the ones who are sticking around. Let's say I am going to be a long term investor -- is it important that I have a broad base of fellow shareholders? Not to me personally. What matters more to me is when I get more in dividends than I spend, so I have to reinvest a good portion on an after-tax basis. Then I've only got 67 cents on the dollar left to reinvest. And that's really destructive to my buying power. A dollar of dividends comes from a blue chip stock, but I only keep 67 cents after paying tax. Where the heck am I going to find blue chip stocks priced at less than 67 cents on the dollar??? That's why dividends are value destructive. I basically get payed only 67 cents and then wind up investing it back into the stock which is priced near a full dollar (most blue chips are not heavily discounted). The dividend rate for me is up to about 33% now -- 20% Federal, then 13% California, then the extra Obamacare/Medicare (or some sort of new health related) investment surtax crap. That takes my $1 of dividend down to only 67 cents. That's practically 2/3. It's just as value destructive as paying 150% of fair value in a stock buyback! So when people say (like it's some religion) that buybacks only make sense under fair value, I think not! There's a lot of room above fair value before they are more value destructive than dividends. Additionally, if I'm going to be losing 33% of value, I'd rather it go to fellow investors than the government tax collector.

In the USA, the qualified dividend rate is the same as the long term cap gains rate. All of my comments pertain to the USA if there was any confusion. Any place where your cap gains rate is higher than your dividend rate (like Warren Buffett at Berkshire) you can take the other side. So that guy is no worse off if he chooses to sell tiny amounts in lieu of a dividend. And he's better off if he wants it reinvested (tax free reinvestment). And being an old guy, his heirs probably want that as well given that it will all be stepped-up in cost basis upon his death. They can either sell his shares (getting all those reinvested buybacks tax-free), or they can choose to keep the shares and start selling pieces to offset buybacks -- with the cap gains paid at the new stepped-up cost basis.

But if you were speaking on behalf of Berkshire shareholders, well then you very well may be very resistant to my scheme. Berkshire pays 35% tax rate on capital gains and 14.5% tax rate on dividends. So, where do you think their spokesperson stands on this issue? Eh?

I don't follow here. Well, the shareholder is no longer getting a 28 cent per quarter cash dividend any longer (it was cut to zero). Let's say the shareholder has 100,000 shares. In the old days, he would get $28,000 of cash dividend each quarter. Under my regime, the company will be using that very same $28,000 (28 cent per share per quarter) to repurchase shares. Now (under my regime), he just sells shares each quarter amounting to $28,000 cash proceeds. He might not even owe any tax on this (depends on his cost basis). Potentially he sold for a capital loss and can actually take the $28,000 distribution completely tax free, as well as reducing his capital gains tax bill from other sales. Compared to the world where he's automatically paying tax on $28,000 of dividend, that's a huge leap forward for mankind. And what about the little shareholder who only owns 1 share? Well, tell me this -- how in the hell is he going to reinvest a 28 cent cash dividend when the brokerage charges him $8 per transaction? He's better off just having it reinvested back into the shares because an investor that small suffers too much expense drag from commissions. And when the share count gets too low from years of constant share repurchases? Just split the stock.

Let's take it without the inverted offering. Let's say, for example, that I'm running Coca Cola (KO) as dictator of the company. I simply convey that I'm going to cut the dividend to zero and instead purchase 28 cents per share of stock every quarter, trying as best I can to make an even-sized purchase each and every day. The shareholder merely needs to make 28 cents worth of sales, each and every quarter. Voila! The prices each shareholder sells at might not be exactly the same (sometimes higher, sometimes lower), but over time that will completely wash out. After all, we're talking about long-term shareholders, right?

People who choose not to exercise their right to tender shares at X price indicate their intentions by a certain date, after which time the company offers that tender price 'X' to the open market. Therefore, the company will be able to distribute all the cash it intends to distribute. Those shareholders that wish to take their pro-rata share of cash will tender their shares at that X price. Those that don't tender their shares made a conscious decision to reinvest their share of the cash at that X price -- forever shall they hold their peace.

They can get out if there is a buyer -- and the company is that buyer. Therefore, there must be a way for them to get out of the shares that the company is repurchasing. There must be some way that a company can issue a reverse rights offering -- in other words, a right to sell at a certain price. Say you have 100,000 shares and the company issues you the rights to sell 1,000 shares at a given price. There you go, it's a tax-efficient way of returning capital to shareholders. Every shareholder can participate. Management should prefer this method of buying back shares because the shareholders can no longer blame management for the capital allocation decision -- it will be plainly obvious that it was their choice not to sell to the company, the allocation decision is squarely on the shoulders of the shareholder. To be sure, a shareholder cashing out via company repurchase is being bought out by the remaining shareholders. You can follow this process to its logical end, where just 1 share remains. But the final shareholder can't cash himself out at an inflated price. To update my previous example: 100 shares and $1,000 in net assets. IV of $10 per-share. 99 shares are repurchased for $10.10. After the repurchase, 1 share remains and its value is $0.1. The company can't repurchase this share, right? That's why I'm saying that as a group the shareholders can't get out. If the company can repurchase this final share, it certainly can't do it at a price above 10 cents. Contrast that repurchase price to the "bargain" repurchase price of $5 per-share. When 99 shares are repurchased, per-share value rises from $10 to $505. All that said, I'm willing to be wrong here. I'm glad you're willing to be wrong :D Kidding aside, My example was for an inverted rights offering. You see, the company gives each shareholder the right to sell 1% of shares back to the company. So you're wrong (and willing to be) if you were disagreeing with me -- the person isn't cashing out at the expense of remaining shareholders, he is merely cashing out at his own expense. In other words, the shares he cashes in are purchased with his pro-rata share of the company cash. Just like when he gets a 1% dividend -- it's not paid at the expense of other shareholders is it? No, it's paid at his own expense. Just like with the inverted rights offering, it's just his pro-rata share of what the company is returning in cash. The reason why I introduced this concept of inverse rights offering was to totally eliminate the argument that shareholders are being cashed out at the expense of existing shareholders.

They can get out if there is a buyer -- and the company is that buyer. Therefore, there must be a way for them to get out of the shares that the company is repurchasing. There must be some way that a company can issue a reverse rights offering -- in other words, a right to sell at a certain price. Say you have 100,000 shares and the company issues you the rights to sell 1,000 shares at a given price. There you go, it's a tax-efficient way of returning capital to shareholders. Every shareholder can participate. Management should prefer this method of buying back shares because the shareholders can no longer blame management for the capital allocation decision -- it will be plainly obvious that it was their choice not to sell to the company, the allocation decision is squarely on the shoulders of the shareholder.

Wise words. I find it hard to believe that Ben Graham "invented" value investing. Buy low, sell high is what merchants, investors, and bankers have been trying to do for aeons. Graham just created a nice intellectual framework for capital markets investing. Jeremy Grantham wrote something really funny about this in the April 2010 quarterly GMO report: So I have come, friends and Romans, to tease Graham and Dodd, not to praise them, even though this is the 75th anniversary of Security Analysis. And my second point of attack is that Graham and Doddery is all a little obvious. I was brought up by a Quaker and a Yorkshireman – that is known as “double jeopardy” in the frugality business. Quakers believe waste to be wicked and Yorkshiremen, who consider Scotsmen to be spendthrifts, consider itcriminal. The idea that a bigger safety margin is better than a smaller one, that cheaper is better than more expensive, that more cash is better than less cash, deserves, in modern parlance, a “Duh!” It is just rather obvious, and going on about it for 850 pages can get extremely boring.

If only we had a 300 year old investor on the forum. He'd probably tell us it was called something else before it was called "buy low sell high". Then later it was called "margin of safety". And he would expect if we waited long enough a new breakthrough label for it would be adopted. The new generation always wants to challenge the orthodoxy and create something new of their own. Leave their own thumbprint on time. But the more things change, the more they stay the same.

IMO, "margin of safety" is lipstick that an English major slapped onto "buy low".