Financial Beat

By Bernice Napach, Senior Editor

Mutual Funds
When not to purchase shares

Beware of buying mutual funds on the last day of a year or quarter. If you do, it's likely that you'll pay a premium for very recent past performance. Funds tend to beat the market on those final days as managers try to boost share prices and the rankings of their funds (as well as their personal year-end bonuses). The following day, those funds often underperform.

A recent study found that from 1985 through August 1997, 81 percent of equity funds outperformed the S&P 500 on the year's last trading day, but only 37 percent repeated that performance the following trading day. The pattern was strongest among aggressive growth funds. Similar but less pronounced patterns were found for the first, second, and third quarters.

The evidence suggests that fund managers engineer "higher closings to increase one period's return at the expense of the next," write the study's authors, who are from The Wharton School of the University of Pennsylvania, the Graduate School of Business at the University of Texas at Austin, and Goldman Sachs Asset Management.

Stocks
A bad January often means a bad year

The stock market's recent stumbles may have been foreshadowed in January. Since 1945, the Standard & Poor's 500 Stock Index has declined in January only 18 times, and 11 of them led to a loss for the full year. The average drop: 11 percent. Even during the seven years when the index ended the year on a positive note after a negative January, the gain averaged less than 5 percent. This past January, the S&P 500 fell 5.1 percent.

Don't give up on the market just yet, however, advises Arnold Kaufman, editor of S&P's Outlook newsletter. Economic growth continues to exceed expectations, he says, and the hike in interest rates by the Federal Reserve Board to keep inflation in check should help extend the current record-breaking expansion. A strong economy, of course, benefits stocks.

Another optimistic note: The market had an excellent fourth quarter in 1999. Since 1935, every time the S&P 500 gained 10 percent or more in the final quarter—there were eight such years—the index advanced in the following 12 months. The average increase: 19.1 percent.  

Bonds
Stick with short-term Treasuries

If you're in the market for Treasury securities, your best bet could be bonds that mature in 10 years or less. They currently yield more than longer-term securities, whose supplies are dwindling. A 10-year Treasury bond yields about 6.8 percent these days, compared with 6.1 percent for the 30-year bond. Even the one-year Treasury note, at 6.3 percent, has a higher yield than the 30-year bond.

It's highly unusual to have longer-term bonds yield less than short-term securities. This so-called "inverted yield curve" is a result of the federal budget surplus. The government has less need to borrow money, so it has been issuing fewer bonds, especially long-term ones, and buying back older, high-yielding bonds. This year, for example, Uncle Sam will issue fewer than half the 30-year bonds he did last year. No other Treasury security will be cut back as much. The reduction has boosted the relative price of long-term bonds (compared with short-term issues) and decreased their yields, which move in the direction opposite to price.

If you own any long-term Treasuries, you might want to sell them soon to collect a capital gain. Or you can wait for the government to buy them back, but that will take some work on your part. The Treasury will not contact you. To find out whether your bond will be bought back, you have to contact a "primary dealer." The dealer can redeem it for you. Names of those dealers can be found at the Web site of the Federal Reserve Bank of New York, at www.ny.frb.org. Search for "list of primary dealers."

Taxes
A sleazy scheme gets a doctor in trouble

Frank W. George II, an Arizona osteopath, established a trust to collect his medical practice's income. He also transferred ownership of his home, in which he operated the practice, to the trust. Then he used money from the trust to pay his personal and business expenses. The idea was to slash his income taxes.

Since the doctor formed the trust in mid-1993, much of his 1993 income could not be funneled into it, but almost all his 1994 income was. His 1040 Schedule C (self-employment income) reported a gross revenue of just over $15,000 in 1994, almost 80 percent less than he had reported for 1993. The tax return for the trust included the doctor's medical income and expenses as well as payments to two entities that presumably funneled money to the doctor. The return did not indicate the tax identification numbers of these entities, which is required by law to show that they are legitimate beneficiaries. That omission drew the IRS' attention.

The trust is "a sham . . . that lacked economic substance," and its income is taxable to the doctor, proclaimed the Internal Revenue Service. George appealed, and on the day his case was set for trial in Tax Court, he filed for bankruptcy, which automatically stalled the case. The court had the stay lifted almost immediately, and hit George with a bill of $62,625 for income taxes owed plus penalties for negligence.

"The only purpose for the transfer of property to the trust was tax avoidance," the court said. It also noted that a trust is generally not legitimate if the person who set it up operates it as if it were his own property.  

Did you know?

• The current economic expansion has set a new record, having lasted 107 consecutive months as of February? If the boom continues, it will move into its 10th year at the beginning of April. The previous record was the 1960s' expansion, which stretched 106 months, from February 1961 through December 1969.

• Consumer confidence has also hit a new high? In January, the monthly index soared to a level never seen in its 32-year history. Low unemployment and the strong economy accounted for the surge in consumer confidence, which is a considered a good predictor of consumer spending. Further gains in consumer spending bode well for an even longer expansion.

• The federal budget surplus could reach nearly $2 trillion by 2010? That's the most optimistic scenario painted by the Congressional Budget Office, and it assumes that federal spending will be capped at current levels. Even the CBO's most pessimistic forecast, which adjusts current spending levels for inflation, estimates a $838 billion surplus over 10 years.

Travel
Consumers to airlines: Straighten up and fly right

The consumer complaint division at the Department of Transportation is getting to be a busy, busy place. An increasing number of inconvenienced airline passengers are taking the time to sound off.

Consumer complaints filed with the DOT more than doubled in 1999, to 20,495 from fewer than 10,000 the previous year. Delays, cancellations, and missed connections topped the list, followed by problems with customer service, baggage handling, reservations, ticketing, and boarding.

Among the 10 major US carriers, America West had the most complaints and Southwest the least—similar to their rankings in 1998. America West also placed last for on-time arrivals, while TWA, which significantly improved its on-time performance, placed first. American and US Airways lost ground. On-time arrivals for the 10 major airlines slipped to 76 percent of all flights in 1999, from 77.2 percent the previous year.

 

Bernice Napach. Financial Beat. Medical Economics 2000;6:31.