Financial Beat

By Bernice Napach, Senior Editor

Investments: A year full of surprises

Among investors, 1999 will be remembered not only as the yearwe sweated out Y2K, but also as a time when many longstandingmarket trends reversed. Here's a sampling.

• The S&P 500 Stock Index lost its standing as the No. 1 performing equities index. The large-cap index was overtaken by the Nasdaq Composite Index, which soared 86 percent, more than four times the gain of the S&P 500. On Dec. 29, the Nasdaq topped 4000—a new milestone, reached in record time. Less than two months earlier, it had first climbed above 3000.
• Tech stocks, propelled by the Internet's explosion, outdid themselves, and their gains fueled the advance in the tech-heavy Nasdaq. Not only did shares of Internet companies soar, but shares of companies that benefit from Internet commerce did also, including manufacturers of computer hardware and software.
• Small-cap stocks rebounded. The Russell 2000 Index, composed of 2,000 small-cap stocks, spent most of the year in retreat, posting a decline for the first 10 months of 1999. But then it came alive, and by Dec. 31, it had hit a record high of 505—a gain of 19.6 percent for the year. That's an eyelash more than the rise in the S&P 500, which was up 19.5 percent.
• International stocks recovered. Asian, Latin American, and European markets all did well, following several years of declines or ho-hum performance. Underpinning the recovery in Asia was an improved Japanese economy and strength in tech stocks. The tech-heavy Hang Seng Index, in Hong Kong, set a new record in late December.

Mortgages: Higher limits for conventional loans could save you money

This year, you can get a home loan for as much as $252,700and still pay the conventional mortgage rate instead of the higherjumbo rate. Both Freddie Mac and Fannie Mae—two government-charteredcorporations that buy mortgages from lenders and repackage theminto securities—have raised the loan limit for conventional mortgagesfrom $240,000. The new ceiling reflects a 5.3 percent increasein the average price of a home in 1999.

That's good news for homebuyers, since mortgage rates havebeen rising rather steadily. Interest on a 30-year conventionalfixed-rate mortgage is currently 7.8 percent, up from 7.0 percentlast April. On a 30-year jumbo loan, the rate is 8.1 percent.The new borrowing limit will save a homebuyer approximately $16,000over the life of a 30-year, fixed-rate $250,000 loan, accordingto Freddie Mac and Fannie Mae.

One result of the higher interest rates is that an increasingpercentage of home buyers are choosing adjustable rather thanfixed-rate mortgages. A typical one-year ARM currently charges6.4 percent.

Computers: Are rebates worth the trouble?

Many computers are now sold with the promise of a rebate, typically$400, if you sign a three-year contract with an Internet serviceprovider (ISP) such as CompuServe. Just sign up with the ISP,the salesperson says, and watch your mailbox, or get an instantrebate when you pay for your computer. Some stores give you moneyright away; others require that you mail in a rebate form. Inthe latter case, you could be waiting for months, if the rebatearrives at all.

To make sure you receive a mail-in rebate, ask for an applicationwhen you buy the computer. The clerk won't always offer it. Thenfill it out carefully, and don't forget to include the store receiptand the bar code from the computer's box when you mail it in.Keep copies of everything.

If you're lucky, you'll get your money in 2 1/2 months. Butin most cases, you'll have to pay two to three months' worth ofISP charges before the rebate arrives. And the eight- to 10-weekclock that most rebate processors follow may not start until theyenter your data into their computer system, which can add anothertwo weeks to your wait.

Is the deal worthwhile? Possibly, but Joseph Mahoney, spokesmanfor the New York State Consumer Protection Board, offers thesecaveats on all rebates: Realize that you're locked into that ISPfor the length of the contract. And be sure it can support thefastest modems.

Insurance: Long-term care policies remain unpopular

After you've reached 65, there's a 40 percent chance you'llend up in a nursing home sometime before you die. Given thoseodds, have you purchased a long-term care insurance policy yet?Fewer than 10 percent of those who should have this protection(people 60 and older who may not be able to fund nursing homecare on their own) have bothered to secure it, according to anAM Best Co. survey of 21 insurers.

High prices, inexperienced agents, and consumer misinformationare to blame for the slow sales, says the Oldwick, NJ, insurancerating firm. Some consumers mistakenly believe that traditionalhealth insurance policies or Medicare cover long-term care. Othersget mixed advice from "experts" about when to buy sucha policy. So they procrastinate.

The typical annual premium for a long-term care contract is$1,251 to $1,500 for the average policyholder, who is 72 yearsold. Younger buyers obviously pay less, assuming they're relativelyhealthy. After years of stable or falling prices, however, premiumshave begun to rise as insurers try to build reserves after payingout larger-than-expected claims. Consider this a wakeup call.

Most policies will pay a maximum $200 to $300 per day for nursinghome care. Payments, however, won't kick in until you're unableto perform two to three typical daily activities such as dressingor bathing yourself. The most popular plans combine nursing homebenefits with payments for home health care, assisted living,and day care, as well as other flexible benefits.

Taxes: Another trust caught in the IRS' crosshairs

Warning: Don't try to take any tax-free distributions froma charitable remainder trust. If you do, the IRS will probablysoon be able to shut the trust down and slam you with a huge taxbill. It has proposed regulations, retroactive to last October,designed to eliminate any improper tax-free distribution fromthese trusts to anyone other than the charitable beneficiary.

A charitable remainder trust is set up to provide funds toa charity after the donor dies. Meanwhile, however, the donorgets a tax break for the assets he contributed to the trust, andhe can collect income from the earnings of those assets. Thatmoney is taxable so long as it comes from the trust's earningsand not its principal.

For years, donors have schemed to avoid paying those taxes.Their latest "strategy" is now the IRS' newest target.Here's how it works:

The donor contributes highly appreciated assets to a charitableremainder trust that has a relatively short term, such as twoyears, but stipulates a large payout to the donor or members ofhis family during that time.

Rather than sell assets for cash to make those payouts, whichwould be taxable to the donor, the trust borrows money againstits assets or enters into a forward sale of some assets. (A forwardsale is a contractual promise to sell certain assets for a specificprice at a future date.) In exchange, the trust collects cashequal to a portion of the asset value. And the donor withdrawsit. Since the money obtained from the loan or the forward saleis not considered income from the trust, it's not taxable.

No longer true, says the IRS. The agency is so hopping madabout this tax avoidance scheme that it is threatening to disqualifytrusts that use it. Donors could find themselves not only payingtaxes on distributions recharacterized as taxable, but also facingpenalties—and losing the deduction they took for setting up thetrust in the first place.

Stocks: What an election year means for Wall Street

If history repeats itself, stocks should continue to rally,because this is a presidential election year. The Standard &Poor's 500 Stock Index has advanced in 11 of 13 election yearssince 1948, gaining an average 12.3 percent. Even during the twoelection years when stocks fell—1948 and 1960—the decline averageda mere 1.9 percent.

Why the election-year boom? During election years, goes onetheory, the incumbent president tries to stimulate the economywith lower taxes or increased government spending, or both. Andthe Federal Reserve, whose chairman in many cases was appointedby the sitting president, usually tries to cooperate by fosteringsteady economic growth. This year, however, that may involve raisinginterest rates again.

Regardless of the theory, stocks have done slightly betterin years when a Republican was elected president. During the postwarperiod, the S&P 500 gained an average 11 percent in the sevenyears when the GOP took the White House, and 9 percent in thesix years when a Democrat won.

The investment picture often changes the year following a presidentialelection, however. The S&P 500 fell in six of the 13 post-electionyears since 1948, five of them when Republicans won. (Jimmy Carterwas the only Democratic president who saw the stock market declinein the year after his election.) Moreover, several bear marketsbegan the first year of a new presidential term—in 1969, 1973,1977, and 1981.

So which party will win the White House this year? If the marketis any indicator, probably the Democrats. Since 1900, says S&P,annual gains of 9 percent or more over a president's four-yearterm have usually kept the incumbent party in power.

Bernice Napach. Financial Beat.

Medical Economics

2000;3:22.