YOUR FINANCIAL FUTURE

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1 YOUR FINANCIAL FUTURE March 2013 In This Issue Strategies for Managing Volatility Asset allocation, diversification, and the use of dividend-paying stocks are potential strategies for reducing volatility. Independent Investor March 2013 I hope this educational resource proves helpful. I believe an educated investor is a better investor. Please call me if you have questions. Robert Vettorel Washington Financial Wealth Management Division Senior Vice-President 77 South Main Street Washington, PA Fax: robert.vettorel@lpl.com inancial.com Small-business owners can choose from two basic types of financing: debt, which is a promise to repay borrowed amounts over a certain time with a specified interest rate and other terms, or equity, which requires you to give up a portion of your ownership interest in - and control of - your company in exchange for cash. This article will look at both types of financing and explore how they may be used for different purposes. Saving for College: Understanding 529 Plans Looking to save for your child's education? You have a number of tax-advantaged federal and state college savings vehicles at your disposal, including the 529 plan. Thinking About a Roth IRA Conversion? Beware the Medicare Surtax Those with traditional IRAs who are considering converting to a Roth IRA should remember the new 3.8% Medicare surtax on singles who earn more than $200,000 and married couples who earn more than $250,000. Finding the Right Retirement Plan for Your Business As a business owner, one of the most vital steps you can take to take care of those you hire is to create an appealing benefits package, including a retirement plan. Here is a summary of some of the options available to you.

2 2 Strategies for Managing Volatility Investors are exposed to financial risk in two ways: company-specific risk or market risk. Long-term investors can reduce exposure to company-specific risk by diversifying among many different securities within the same asset class. 1 Market risk is managed, but not eliminated, by holding investments in several different asset classes. When using individual securities, 50 may be needed to diversify an equity portfolio. Low Correlation: The Key to Effective Asset Allocation Longer term, the market risk associated with an individual asset class, such as stocks, may be reduced by allocating a portion of a portfolio's assets to other types of investments that historically have reacted differently to market and economic events. 2 A statistic known as correlation measures the tendency of two investments to move together. A correlation close to zero indicates that two investments are largely independent of each other. The closer a correlation is to 1.00, the greater the tendency two investments have had to move in tandem. The table below lists four assets that have had relatively low correlations with U.S. stocks during the past decade. Past performance does not guarantee future results. A Look at Correlation Commodities Cash Investment-Grade Bonds Home Prices Large-Cap Stocks Sources: S&P Capital IQ Financial Communications; Barclays Capital. Large-cap stocks are represented by the S&P 500 index, commodities by the Standard & Poor's GSCI, cash by the Barclays 3-Month Treasury Bill Index, investment-grade bonds by the Barclays Aggregate Bond Index, home prices by the S&P/Case-Shiller 20-City Composite Home Price Index. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price. Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest, and if held to maturity, offer a fixed rate of return and fixed principal value. Exposure to the commodities markets may subject investors to greater volatility as commodity-linked investments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates, or factors affecting a particular industry or commodity. You cannot invest directly in an index. Past performance is not a guarantee of future results. Data is based on the 10-year period ending December 31, Managing Single-Security Risk Modern portfolio theory is founded on the assumption that investment markets do not reward investors for taking on risks that could be eliminated though diversification. A 2003 study found that at least 50 stocks may be required to provide adequate diversification for an equity portfolio. 3 Fortunately, there are many strategies available for diversifying a stock portfolio. Investors can allocate portions of a portfolio to domestic and international stocks, which may take turns outperforming depending on circumstances in various global economies. 4 An allocation to small-cap, midcap, and large-cap stocks also provides exposure to companies of various sizes. Although there are no guarantees, smaller companies may be nimble enough to exploit untapped market niches and capitalize on growth potential. 5 Dividend Strategies In addition, equity investors looking to limit volatility may want to consider dividend-paying stocks. Although a company can potentially eliminate or reduce dividends at any time, a dividend may provide something in the way of a return even when stock prices are volatile. When evaluating dividend-paying stocks, it may be worthwhile to review how long a company has paid a dividend and whether the dividend has increased over time. According to a study by Standard & Poor's, firms that had increased their dividends for the past 25 years outperformed the S&P 500 and also were less volatile during the 5-year, 10-year, and 15-year periods ending December 31, Past performance does not guarantee future results. 6 While the top tax rate on qualified dividends increased in 2013, it is still much lower than the top rates on ordinary income for most taxpayers. For investors interested in managing volatility, asset allocation with low-correlation investments, diversification, and dividend-paying stocks may be worth considering.

3 3 1 There is no guarantee that a diversified portfolio will enhance overall returns or outperform a nondiversified portfolio. Diversification does not ensure against market risk. 2 Asset allocation does not assure a profit or protect against loss. 3 Source: H. Christine Hsu and H. Jeffrey Wei, "Stock Diversification in the U.S. Equity Market," Foreign stocks involve greater risks than U.S. investments, including political and economic risks and the risk of currency fluctuations, and may not be suitable for all investors. 5 Securities of smaller companies may be more volatile than those of larger companies. The illiquidity of the small-cap market may adversely affect the value of these investments. 6 Source: Standard & Poor's. Returns are based on the Standard & Poor's Dividends Aristocrats portfolio. Volatility is measured by a statistic known as standard deviation. Past performance does not guarantee future results S&P Capital IQ Financial Communications. All rights reserved

4 4 Independent Investor March 2013 Small-Business Financing: Debt vs. Equity Business owners who seek financing face a fundamental choice: Should they borrow funds or take in new investment capital? Since debt and equity are accounted for differently, each has a different impact on earnings, cash flow and taxes. Each also has a different effect on leverage, dilution of ownership and a host of other metrics by which businesses are measured. The planned use of funds will also affect the choice of financing, with one option more appropriate for certain uses than the other. Debt Debt can be a loan, line of credit, bond or even an IOU--any promise to repay borrowed amounts over a certain time with a specified interest rate and other terms. Debt is accounted for as a liability of the company, and interest payments are deductible business expenses. In the event of bankruptcy or insolvency, debt holders take priority over equity holders. For a small business, debt financing has both advantages and disadvantages. On the plus side, debt can be relatively simple to secure through a bank or other financial institution and is available with a broad range of terms, allowing you to customize the debt to meet your specific needs. Whether you are seeking a three-month bridge loan or a long-term commitment, you can usually find an institution that is willing to work with you. And since most debt entails regularly scheduled payments of interest and often principal as well, debt is easy to plan around. Perhaps most important, debt, unlike equity, will not dilute your ownership interest in your company. On the negative side, however, financing with debt can be more expensive, and you will have to meet scheduled interest and principal payments regardless of your cash flow. Although loan terms can be negotiated to build in flexibility, ultimately the money must be paid back. Debt is most often used to fund a specific project or initiative that has an identifiable implementation time frame. It is also used as a cash flow backup in the form of a revolving line of credit. To attract lenders, you will need to have a good personal and business credit history, sufficient cash flow to repay the loan and/or sufficient collateral to offer as a second source of loan repayment. In smaller businesses, personal guarantees are likely to be required on most debt instruments. You also should not be carrying significant debt already. Equity Equity differs from debt in that it represents a permanent ownership stake in the company. When you finance with equity, you are giving up a portion of your ownership interest in--and control of--the company in exchange for cash. Equity investors may demand dividends or a portion of annual profits. But most investors in small businesses seek long-term capital gains on their investment, meaning that at some point these investors may look to opt out. This can mean the eventual sale of the business or the need to bring in replacement investors in the future. The most common sources of equity financing for small businesses are personal savings or contributions from family, friends and/or business associates. Venture or seed capital companies can also be sources of new capital, although they generally deal in larger financings. If your business is incorporated, anyone contributing equity capital would receive shares in the business. If it is a sole proprietorship or a partnership, they would receive an ownership share of the business. While equity financing can be used for many different purposes, it is usually used for long-term general funding and not tied to specific projects or time frames. The major disadvantage to equity financing is the dilution of your ownership interest and the possible loss of control. Moreover, equity investors in smaller businesses generally look for high returns over time to compensate for the risk they are assuming. Striking a Balance In practice, most businesses use a combination of debt and equity financing. The trick is getting the right balance. If you have too much debt, you may overextend your ability to service the debt and can be vulnerable

5 5 to business downturns and changes in interest rates. On the other hand, too much equity dilutes your ownership interest and can expose you to outside control. The mix that best suits your company will depend on the type of business, its age and a number of other factors. For a small business, a local community bank may consider an acceptable debt-to-equity ratio to be between 1:2 and 1:1, although debt ratios vary significantly from industry to industry. Startups and newly launched firms will likely be heavily weighted toward equity since they have not had time to establish a credit history and may face negative cash flow in the early years. Whatever your mix, keep in mind that you can often negotiate terms with both lenders and investors. This article was prepared by S&P Capital IQ Financial Communications and is not intended to provide specific investment advice or recommendations for any individual. Please consult me if you have any questions. Because of the possibility of human or mechanical error by S&P Capital IQ Financial Communications or its sources, neither S&P Capital IQ Financial Communications nor its sources guarantees the accuracy, adequacy, completeness, or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall S&P Capital IQ Financial Communications be liable for any indirect, special, or consequential damages in connection with subscribers' or others' use of the content. Tracking #:

6 6 Saving for College: Understanding 529 Plans Expecting a bundle of joy and wondering if you will be able to afford sending him or her off to college? Fortunately, you have a number of tax-advantaged federal and state college savings vehicles at your disposal, including the 529 plan, which comes in two varieties: the prepaid tuition plan and the savings plan. Most 529 savings plans offer a menu of age-based portfolios, and some also offer a small selection of stock and bond funds. The Prepaid 529 Plan A prepaid plan allows you to pay now at today's rates for school tomorrow. In return, your account is guaranteed to pay for the tuition and fees at the state's public universities and colleges by the time your child graduates from high school. Note that prepaid plans often do not cover the costs for room and board. Your child also may use the prepaid account to attend a private or out-of-state school, but you might risk forfeiting some of its value depending on how the plan values its contracts. Note, too, that most prepaid plans require that you or your child be a resident of the state in which the plan is offered. The 529 Savings Plan The 529 college savings plan is far more flexible than the prepaid tuition schemes. The money accumulated may be used at any school you choose and for all qualified higher education expenses, including room and board. Each state determines what the lifetime contribution limit or account balance cap will be in its 529 plan, but typically such limits range between $100,000 and $270,000. Investment minimums are low (most plans let you sock away as little as $25 a month as long as a minimum of $500 is accumulated within two years of the initial purchase date), and there is no restriction on how much you may contribute every year unless the account is nearing the lifetime cap. However, since 529 contributions are treated as gifts subject to gift-tax limitations, if you want to make a tax-free contribution, it shouldn't exceed $14,000 annually ($28,000 if you're contributing with your spouse). There's one exception, however: You may contribute as much as $70,000 tax free in one year ($140,000 with your spouse), but that contribution will be treated as if it were being made in $14,000 installments over the next five years. That means you can't make other tax-free gifts to the beneficiary during that time. Most 529 savings plans offer a menu of age-based portfolios, and some also offer a small selection of stock and bond funds. In the former case, your annual contributions get invested in a pre-selected portfolio of stocks and bonds. Early on, the portfolio is tilted toward stocks, and as the time for college nears, the weighting shifts toward bonds. You can switch investments up to twice a year. The quality of 529 college savings plans varies by state, but in most instances you may open an account in any state you'd like. All 529 plans offer generous tax breaks, provided you use the money for qualified expenses. While your contribution is not deductible on your federal taxes, your investment will grow tax-deferred and withdrawals will not be subject to federal tax. You should always compare the 529 plan of your choice with any 529 college savings plan offered by your home state or your beneficiary's home state and consider, before investing, any state tax or other benefits that are only available for investments in the home state's plan. You should always read the Plan Disclosure Document which includes investment objectives, risks, fees, charges and expenses, and other information. You should read the Plan Disclosure Document carefully before investing. Investment Risks Investing in college savings plans comes with some risk. Unlike prepaid tuition plans, they don't lock in tuition prices. Nor does the state back or guarantee the investments. There also is the risk with most college savings plan investment options that you may lose money or your investment may not grow enough to pay for college S&P Capital IQ Financial Communications. All rights reserved

7 7 Thinking About a Roth IRA Conversion? Beware the Medicare Surtax Financial advisors usually recommend that taxes associated with a Roth IRA conversion be paid from assets outside of the Roth IRA account so as not to disrupt retirement savings. Thanks to legislation that took effect in 2010, investors at any level of income can convert a traditional IRA to a Roth IRA. If you are planning on converting your traditional to a Roth, there are a few things to consider. The most important consideration: The conversion from a traditional IRA to Roth IRA increases your marginal tax rate. And it could push you into paying the 3.8% Medicare surtax that went into effect on January 1, The surtax impacts single filers with an income of more than $200,000 and those married filing jointly taxpayers who earn more than $250,000. Still, a conversion to a Roth IRA could still make sense, especially with continued market volatility. Smaller balance = smaller tax bite: A conversion triggers a tax bill on the amount of money that is converted, so a smaller account balance results in a smaller tax bite. Hedge against future tax rate increases: Many observers believe that federal taxes are likely to increase in the years ahead as the federal government grapples with budget problems. Currently, qualified withdrawals from Roth IRAs after age 59½ are tax free, which presents an important benefit for retirement investors. 1 Before deciding whether a conversion makes sense for you, make sure you understand the differences between a traditional IRA and a Roth IRA. The table below includes a summary of some of the key differences. You can learn more details by referencing IRS Publication 590. Traditional IRA Funded with after-tax dollars Contributions may be tax deductible if certain income limits and other considerations are met. For 2013, the maximum contribution is $5,500 (those aged 50 and older can make an additional $1,000 contribution). No income limit to open an account Roth IRA Funded with after-tax dollars Contributions are not tax deductible. For 2013, the maximum contribution is $5,500 (those aged 50 and older can make an additional $1,000 contribution). Income thresholds for contributions do apply and are typically indexed annually to inflation. Distributions must be taken upon reaching age 70½. No distributions are required upon reaching age 70½. Distributions are subject to taxes. Distributions are tax free. If you are considering a conversion, be sure to consult a tax professional to help you calculate the corresponding tax bill. Financial advisors usually recommend that taxes associated with a Roth IRA conversion be paid from assets outside of the Roth IRA account so as not to disrupt retirement savings. You Can Change Your Mind If you convert from a traditional IRA to a Roth IRA and you subsequently change your mind, there is a redo known as recharacterization. In effect, recharacterization is reversing the conversion and moving the assets back to a traditional IRA. Your financial institution can handle this transaction for you. Note that you are required to file an amended tax return. The information in this communication is not intended to be legal or tax advice. You should consult with a financial professional and ERISA counsel to help determine your unique situation and needs. 1 Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted S&P Capital IQ Financial Communications. All rights reserved

8 8 Finding the Right Retirement Plan for Your Business As a business owner, you understand the importance of attracting and retaining key employees. One of the most vital steps you can take to take care of those you hire is to create an appealing benefits package, including a retirement plan. There are many options available to you. Here is a summary of some of those options. Part of the appeal of a 401(k) is the fact that assets are highly portable, meaning that participants can easily transfer balances to other qualified retirement accounts when changing jobs. SEP-IRAs A Simplified Employee Pension plan (SEP-IRA) may be ideal for a one-person business or a business with just a few employees. It is relatively inexpensive and easy to start and administer. The employer -- not the employees -- contributes to a SEP-IRA. Employees are immediately vested, and each employee decides how his or her money is to be invested. Although there are some exceptions, in general, a SEP-IRA must cover any employee who is 21 or older, has earned at least $550 from the business, and has worked there during at least three of the preceding five years. In 2013, the annual contribution limit for each employee is 25% of compensation (or, for the self-employed, net earnings) or $51,000, whichever is less. SEP-IRAs also offer small-business owners flexibility regarding both the amount and timing of contributions. As a result, a SEP-IRA may make sense for a business with profits that tend to fluctuate from year to year. SIMPLE IRAs The Savings Incentive Match Plan for Employees (SIMPLE IRA) is also valued for its ease of administration and is available to businesses with 100 or fewer employees. A "matching" SIMPLE IRA plan allows employees to contribute up to $12,000 of salary in The employer must then make a matching contribution of up to 3% of each worker's annual compensation, but the employer has the right to match as little as 1% in two out of any five consecutive years. The other method for funding a SIMPLE IRA requires the employer to make nonelective contributions equal to 2% of compensation for each worker who has earned at least $5,000 during the year, whether or not a worker has elected to contribute income. 401(k)s A 401(k) plan allows eligible employees to make pre-tax deferrals. Participants decide how much money to contribute to their individual accounts and how to manage their investments up to and throughout retirement. The employer has the option of making matching contributions that can vest immediately or over a graded or cliff schedule. Part of the appeal of a 401(k) is the fact that assets are highly portable, meaning that participants can easily transfer balances to other qualified retirement accounts when changing jobs. Participants may contribute up to $17,500 for those aged 50 and over can add another $5,500. Total contributions to an individual's account cannot exceed $51,000 or 100% of compensation, whichever is less. Roth 401(k)s The difference between a Roth 401(k) and a traditional 401(k) is that the Roth version is funded with after-tax dollars while the traditional 401(k) is funded with pre-tax dollars. An employer may decide to offer both types of accounts. As with a traditional 401(k), participants may contribute up to $17,500 for those aged 50 and over can add another $5,500. For more information on suitable retirement programs, contact your financial professional S&P Capital IQ Financial Communications. All rights reserved

9 The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. Robert Vettorel is a Registered Representative with and Securities are offered through LPL Financial, member FINRA/SIPC. Insurance products offered through LPL Financial or its licensed affiliates. Washington Financial Wealth Management Division is not a registered Broker/Dealer and is not affiliated with LPL Financial Not Bank/Credit Union Not FDIC/NCUA Insured Guaranteed Not Insured by any Federal Government Agency May Lose Value Not a Bank Deposit This newsletter was created using Newsletter OnDemand, powered by S&P Capital IQ Financial Communications.