Political Magic with Smoke & Mirrors

Not since the late 1990s has there been such a political illusion as we are currently witnessing!

During President Bill Clinton’s Presidency they came up with ways to balance the Federal budget.  I believe a large part of this was allowing individuals to move their IRA accounts into Roth IRA accounts.

A little back ground is needed here:

1. An IRA account is designed to help individuals prepare for retirement by:

·                    Allowing individuals to put pre-tax dollars into an IRA.

·                    Allowing the investments in the IRA account to grow tax free.

The investments in an IRA account are then taxed when they are withdrawn during retirement.

2. A Roth IRA account is designed to help individuals prepare for retirement but with a few twists:

·                    Dollars invested in a Roth IRA account are after tax dollars, rather than pre-tax as in a normal IRA account.

·                    Investments in the Roth IRA account still grow tax free while they are in the account.

·                    However, when the money comes out of the Roth IRA it comes out tax free.

During President Clinton’s Presidency they allowed individuals to switch from their individual IRA accounts to new Roth IRA accounts during 1 year, but pay taxes on the money transferred into the Roth IRA account over a 5 year period of time.  There were a large number of very wealthy individuals who took the government up on this and many of which no longer pay taxes.

President Obama tried something like this a few years back, but only allowed the taxes to be paid over a 2 year period of time and few people found this tempting.

Fast forward to today and the fiscal cliff:

The threat of much higher individual taxes, capital gains taxes, AMT taxes and dividend taxes on people who have incomes above $250,000 a year has put America’s wealthiest citizens into a panic. They have:

1. Started selling stocks with extremely high gains, to avoid the high capital gain taxes in 2013.
2. They have persuaded companies like Johnson Controls and Bon-Ton Stores to pay their normal dividends early. Instead of paying out their dividend as scheduled in, say, January, they will pay it instead in December to allow shareholders to pay less taxes on the dividend.
3. They have persuaded other companies, like Oracle, to go even further and bundle several future dividend payments into one bigger pre-December 31 payment.
4. They have persuaded other companies like Costco, Carnival and Brown-Forman to borrow money in order to pay a big dividend before the end of the year, on the theory that they are paying future earnings to shareholders at current tax rates, rather than at higher tax rates down the road.

All this is going on as the President, Congress and the Senate appear to be fighting like little children; each wanting to get their way, or they will take their toys and go home.  Or are they really?

Let’s take a step back and look at this.  There have been so many people selling investments and companies declaring larger than normal dividends before the end of the year, to avoid higher taxes in the future, that the taxes that will be collected for the year 2012 tax year should jump up substantially!

If I were the President, Congress and Senate I would not want to settle the budget and tax issues by the end of the year.  I would want just what is going on right now. I would want to have the wealthiest American’s panicked even more, selling more and more of their investments to avoid higher future taxes that may or may not actually happen and/or last.  It helps Washington to reduce the budget deficit. In the long run it might even make all those people in Washington look smarter than they actually are?

Why All The Special Dividends

One of the oddest things to come out of the Fiscal Cliff headlines is the sudden proliferation of so-called "special" dividends. According to a recent article in the Wall Street Journal and another in CBS News, 349 publicly-traded companies have already moved up the date that they are paying their dividends or are paying additional dividends to shareholders, above what they would normally pay.

What makes these dividends so special? Technically speaking, the owners of the shares of a publicly-traded company are, collectively, the owners of that company. You can think of "ordinary" dividends as the money that the company has decided to return to its owners from the profits of its business operations. Each year, the company's management and board of directors decides all over again how much of its profits to distribute; it can increase, decrease or maintain its dividend payout, and even pay out more than its earnings. And, of course, many companies pay no dividends at all; they reinvest their profits in their enterprise or other business activities in hopes of generating more profits and making their company (and stock) more valuable, or they buy back shares of company stock.

These dividends receive special tax treatment under current law; the money is taxed at a maximum 15%--0% for people who fall below the 25% income tax rate. But that special rate will expire at the end of the year, resulting in a maximum rate of 39.6%, as dividends are taxed as ordinary income, and the ordinary income rates rise. Of course, the Fiscal Cliff negotiations in Washington could result in an extension of current rates; the truth is that nobody knows, at this point, what is going to happen with next year's tax rates.

Special dividends are simply a company's decision to pay its shareholders before rather than after the dividend tax rates are expected to go up.

They fall into two categories. In one category, you have companies like Johnson Controls (a technology company) and Bon-Ton Stores (fashion apparel) that are paying their normal dividends early. Instead of paying out their dividend as scheduled in, say, January, they will pay it instead in December as a convenience to shareholders. Other companies, like Oracle, have gone a step further, and announced that they will bundle several future dividend payments into one bigger pre-December 31 payment. Oracle will pay 18 cents per share in December to replace the dividends it would have paid out over the next three quarters.

In the other category, you have companies like Costco, Carnival (the cruise line company) and Brown-Forman (a wine and spirits distributor) that are actually borrowing money in order to pay a big dividend before the end of the year, on the theory that they are paying future earnings to shareholders at current tax rates, rather than at higher tax rates down the road.

The implication of some the news reports is that this is a special opportunity, where an astute investor can buy companies that will pay out a hefty dividend. But in fact, this is almost certainly the wrong strategy. Companies that are going into debt to make dividend payments are robbing Peter to pay Paul. To make a special $7 dividend, Costco will borrow $3.5 billion, tripling its long-term debt and has already caused the Fitch rating service to downgrade the company/s bond rating.

In addition, the payment of a dividend results in a simultaneous drop in the stock's share price. If you buy a company that makes a dividend payment of 79 cents a share, the share price of that company will drop by 79 cents at the same time. You come out exactly where you were before, all-in, except you have to pay taxes on that dividend payment.

And some of these special dividends seem to be driven more by the interests of insiders than a convenience to the outside shareholders. The board of directors of Opt-Sciences, a company that makes special coatings for glass used in cockpits, has announced a special dividend amounting to 65 cents a share, in order, the company said, "to secure for the shareholders the benefits of the soon to be expiring current dividend tax treatment." A nice gesture? It would seem so until you are told that the family of one director, Arthur Kania, controls nearly 66% of the company stock. He may be more concerned about HIS tax bill than yours.

Another problem with these special dividend strategies is that higher taxes are not inevitable. And even if Congress takes us over the fiscal cliff, or if part of the next Grand Bargain is to eliminate special treatment of dividends, it won't be the end of the world--or even the end of tax-efficient ways to reward shareholders. As you can see from this chart, companies shifted strategies dramatically toward dividends precisely when the new lower tax rate was enacted back at the start of 2003. Before that, and perhaps in the future, those same companies will redirect the same money they have been paying in dividends into the repurchase of company stock, raising the value of the shares owned by their investors, or reinvesting the money, raising the value of their enterprises and thereby (again) increasing the value of their stock.
Both options would reward shareholders without forcing them to pay immediate taxes on the amount of the reward--a more tax-efficient strategy that some "special" dividend payers might consider before they go into debt to create a tax liability for their shareholders.

Financial Planning and the National Health Care Tax

With the new National Health Care Tax (3.8%) and the strong possibility of a larger Capital Gain Tax in 2013 (Elections), we need to think differently about our financial tax planning.

New Tax, New Planning: At the start of next year, America's entire tax regime is set to change, as the Bush-era tax rates shift back to their previous (higher) levels, and preferential (lower) rates on capital gains and dividends phase out. The estate tax rates will go up and the exclusion amounts will go down. Congress may intercede between now and then, but in an election year, any meaningful compromise is far from certain.

This has created an unusual level of uncertainty among financial advisors and planners. However, the recent Supreme Court ruling on the 2010 Patient Protection Affordable Care Act (sometimes colloquially referred to as "Obama care") has taken one uncertainty off the table. We now know that a new tax will have to be planned for as of January 1. As a way of shoring up the shaky finances of our Medicare Trust Fund, the budget reconciliation bill that was passed in conjunction with the health care reform bill will impose a 3.8% "Medicare Contribution" tax starting in tax year 2013.

What does that mean to you? For 97% of all house holds individuals whose current taxable income fall below $200,000, or couples with a joint income below $250,000 the tax is irrelevant; it only applies to persons above those income thresholds. (Technically, the actual number would be a modified adjusted gross income, with any net foreign income exclusion amounts added back in.)

People whose income does exceed those thresholds will pay the 3.8% tax on the lesser of two calculations. You would first calculate your overall taxable income minus the threshold amount; the amount above this would be subject tax if it happens to be lower than the second calculation. The second amount is your net investment income; that is, how much you made, in aggregate, on taxable (but not muni bond) interest, plus dividends, distributions from annuities, royalties, net rental income (after deducting for expenses, property taxes, interest expense from debt service and property depreciation), income from passive investments like partnerships, from actively trading financial instruments and commodities, plus the gain from selling non-business property. Of course, you get to subtract out losses and expenses related to those investments.

So, for example, suppose a husband and wife completed their tax forms, and found that they had adjusted gross income of $400,000 in 2013. The first number that the 3.8% tax might be applied to is $150,000 ($400,000 - $250,000). Moving to the second test, let's suppose that they earned interest income amounting to $40,000, and had sold some stocks for a capital gains profit of another $40,000. But they had also sold some stocks at a loss, amounting to $15,000. Their net investment income comes to $65,000. That's obviously lower than $150,000, so that is what the couple pays the Medicare Contribution taxes on. Their MC tax comes to $2,470.

Suppose the couple only earned $265,000 in that same year. They would pay taxes on $15,000 ($265,000 - $250,000) rather than on the investment income.

You might have read that this tax will be imposed on the gains from the sale of your house, but that may not be true. If your income is above the threshold limit, you and your spouse would still have to make a profit of more than $500,000 ($250,000 for singles) on the sale of your house before the tax becomes applicable.

The investment calculation does not include payouts from a regular or Roth IRA, 401(k) plan, Social Security or veterans' benefits, or any income from a business on which you are paying self-employment tax. It also doesn't apply to the appreciation of your stocks or mutual funds until or unless they're sold and gains are taken. However, IRA and qualified plan distributions DO raise your modified adjusted gross income, and this, of course, can put you over the threshold. In years when you have is little investment income, this income amount above the threshold may become the applicable tax base, so you could end up paying taxes on these amounts.

Because the amount of investment income determines, in part, your total income, this is one tax that is rich with planning possibilities. Suppose, for example, that the couple mentioned earlier, whose total taxable income would have been $265,000 if they had taken gains on stocks, decided to take fewer gains, so their total taxable income fell to $249,000? The 3.8% would no longer apply to them, even though they had other investment earnings.

Since the Supreme Court decision, advisors are talking about doing just the opposite of what we normally do: deliberately taking gains this year and deferring losses into next year, either to lower 2013 income below the income threshold or to lower 2013 investment income hit by the 3.8% tax. Others have mentioned the new attractiveness of municipal bonds, whose income isn't affected by the Medicare Contribution tax.

A longer-term strategy is to convert IRA assets to Roth IRA assets in 2012, and pay the taxes out of outside assets. Distributions from the Roth IRA never show up in any of these 3.8% calculations, and the money paid up-front in taxes lowers the taxable income amounts in the future. As a potential bonus, the tax rates in 2012 might be lower than they would be if all the tax rates jump on January 1. Still, it is important to remember that taxes are only one component of your total investment picture. A strategy that simply tries to lower your payments to Uncle Sam may not be the best one for your personal needs, or for building retirement income.  

Medical Insurance Tax Penalties: After the Supreme Court ruling upholding the recent Health Care act, everybody is required to buy health insurance. Or are they?

People who earn less than $9,500 are exempt from the requirement; above those income levels, you would have to pay a tax that depends on your income level. There is a phase-in of rates from 2014 through 2016, but just looking at the 2016 rates, any person with taxable income between $9,500 and $37,000 would have to pay $695 in additional taxes to the IRS.

At higher incomes, the uninsured person would pay 2.5% of taxable income above that $9,500 threshold, meaning somebody with $100,000 of taxable income would have to pay $2,250 in additional taxes, while a taxpayer with $200,000 of AGI would have to pay $4,700 on top of normal tax amounts. Beyond that, the tax would equal the cost of a "bronze" health insurance plan at your state exchange--estimated by the Congressional Budget Office to cost between $4,500 to $5,000 per person, and $12,000 to $12,500 per family.

 In other words, the tax equals the cost of health insurance for persons who earn more than $200,000, and is somewhat less costly than the health coverage would be for persons with lower incomes. As a result, we may see taxpayers simply decide to pay the tax rather than buy the (more expensive) coverage.

Politics drives me crazy!

The recent release of Republican presidential candidate Willard "Mitt" Romney's 2010 and 2011 tax records--all 500 pages of them--has generated a lot of buzz among financial types and mainstream voters. Indeed, people who work with financial planners might be wondering: "why the heck can't my advisor get my federal taxes down to a 14% rate? Couldn't I be parking money in Bermuda (page 52 of the 2011 return) Switzerland (position sold in 2010 after the Swiss bank UBS came under federal investigation for facilitating tax fraud) and the Cayman Islands (called "various countries" on the return) if my advisor were just a little more creative?"

You can see the estimated 2011 return for yourself here: http://mittromney.com/learn/mitt/tax-return/2011/wmr-adr-return, although the home address and the Social Security numbers for Willard M. and Ann D. Romney have been blacked out. What you DO see is a little over $4 million in taxable interest, a little over $3 million in dividends, $10.7 million in capital gains, $2.8 million in income from rental real estate, $110,500 as a member of (the listed profession) "independent artists, writers, performers" and zero for wages or salaries. The estimated tax bill: $3,226,623--about 14% of the nearly $21 million in total income.

This percentage could go down between now and the next filing date. Page 11 of the return says that the Romneys expect to receive a foreign tax credit, which is not yet factored into the tax payment. Pages 30, 31, 32, 33, 34 and 35 note that the K-1 tax information on various partnerships (one called "Rob Rom Enterprises, LLC") is also unavailable, and the tax calculation "may change significantly when the final 2011 K-1 is received."

If you're feeling envious of the low rates, and the fact that much of it was exempt from Social Security payroll taxes, you aren't alone; according to one report, Romney's secretary paid taxes at a higher marginal rate.

There are several ways to look the situation. One is that Romney actually paid MORE than his fair share--in fact, you could argue that he paid much more.

How? The argument goes something like this: if you walked into the grocery store to buy a loaf of bread, would the cost be dependent on your income? If it was, the average American would be paying roughly $2.00 while Mr. Romney's cost would be closer to $300. If we all receive the same basic package of services from the government, and the total cost is about $6 trillion, then each of the 300 million people who live in America would owe about $20,000. Mr. Romney, by paying about $3 million a year, might be considered to be overpaying for his share of those governmental services.

Another way to look at it is that people who have more income or assets have more to protect, and therefore need those government services more than most. A progressive tax system that is capped at the top forces wealthier people to pay proportionately more, but they also get to keep a majority of what they earn. If you buy this philosophy, then the question becomes: how do you decide what is fair for everybody, the high earners as well as the low earners?

One traditional answer is that everybody should pay something. You hear a lot about low-income wage earners paying no income taxes, but in fact they are all required to pay Social Security payroll taxes, which are actually higher than income taxes for the majority of Americans. On the other end of the wealth spectrum, there are so many nuances to the tax code, so many deductions and loopholes, that it was possible for General Electric to largely escape corporate taxes. That isn't possible for individuals, ever since, in 1969, the U.S. Treasury Department disclosed that 155 high-income households had paid no income taxes. In the ensuing uproar, Congress passed the alternative minimum tax--and has been trying to fix it ever since.


There were two reasons why candidate Romney was able to escape the highest tax rate. The first is that his "job" at Bain Capital Management was to--as Warren Buffett has recently described it--"move money around." Specifically, he was investing his own and others' money into companies and then restructuring them. People on Wall Street and in Silicon Valley will tell you that this is real work, hard work, but all too often the result is to shift money from the company to the pockets of the investors. For this sort of work, the tax code applies the same tax rate as the taxes on dividends and capital gains--15% at the high end--rather than the maximum 35% rate that a corporate employee earning similar compensation would have to pay. Even somebody who sweeps the floors or answers the phone at Bain's offices, who earns more than $35,000, would pay taxes at a 25% rate.

The second--lesser--reason why candidate Romney's taxes were so low is that he voluntarily gave $2.6 million a year to his church and a total of more than $4 million in total to charities (Schedule A and page 68). One could argue that his actual financial contribution to society--to his church, to the Bush presidential library, to other charities and the federal government--was actually $7 million a year. That amount would equal roughly a 33% tax rate.

If nothing else, those voluminous tax returns, detailing offshore accounts, capital gains taxes for the same kind of work that corporate executives do and charitable donations, will create a new awareness of the implications of different candidates' positions on tax reform. The New York Times recently noted that candidate Romney's own tax reform proposals would require him to pay less than he does now, suggesting that he supports the idea that he's paying more than his fair share. The Newt Gingrich tax proposal would, if passed, essentially eliminate candidate Romney's tax burden altogether. Interestingly, Mr. Romney has labeled this "irresponsible."

One additional note: the Romney tax return checked the boxes to donate $3 for each spouse to support the Presidential Election Campaign.

Congress fiddles while U.S. burns!

Politicians around the world seemed to have messed things up so badly our investments were making little or no sense, based on history. Or were they? All great empires come and go: Greece, Rome, Italy, Spain, Great Britain and now the United States?

You see we have been looking at the last 10 year wondering what was wrong with the stock markets. We were wondering why they were not performing like they did during the last century. Here is a persuasive argument that we may be overestimating future equity returns and return estimates in our investments, and maybe investing in all the wrong places.

Financial Advisors in the United States (U.S.) tend to use long-term U.S. equity returns as their guidepost for what they expect stocks to do in the future in the United States. Most advisors adapt historical assumptions based on PE ratios and other valuation measures. But if you go back to the beginning, where did these returns come from? They came from our country at the start of the 20th century until now. The United States at the turn of the century was basically an emerging market economy. Then it moved to a developed market and then to the leading economy in the world. During this time the dollar became the world's reserve currency.

Here's the point that affects our planning assumptions: going forward, are U.S. equity returns going to reflect the rapid growth of an emerging market becoming developed, or a developed market becoming the dominant global economy? Have we built in return assumptions that were extraordinary once-in-a-lifetime trajectory of economic growth, along a path which almost certainly cannot be sustained going forward?

If we have: we need to look outside the U.S. to find the returns that would reflect that growth. What we want to do is consistently hitch our wagon to the emerging, developing economies around the world; to the extent we can identify them. That's what U.S. investors did for 100 years in the U.S., by investing in the United States. That may be the only way we get returns like we got from U.S. equities over the past century.

There are a lot of implications here, and potentially a lot to change about our current thinking. So let's start by taking a closer look at the U.S. growth story. In 1900, the estimated total market cap of the world was $18 billion. Europe made up 56%, with Britain comprising 24% all by itself. India accounted for 10% of global market cap, Russia 11% and the U.S. 16%. The U.S. was a smaller, less wealthy country. You could have described it as an emerging economy, even though the term didn't exist back then."

Between 1900 and the mid-1970s, the U.S. share of the world's market cap grew from 15% to over 70%. Be-tween the mid-70s and the end of 2010, the rest of the world caught up dramatically, and the U.S. share of the world's $47 trillion share value had fallen back to 32%. Since 2000, our equity returns haven't been exactly world-beating. Is it possible that this is a better predictor of the future than the time period when the U.S. was increasing its percentage of total market cap and global GDP?

I know we have all be raise to believe that the United States is the best, biggest and most wonderful country in the world and I would agree with you right up until sometime around March of 2000. Looking forward, Jeremy Siegel has projected that by 2050, the U.S. share of global market cap will have fallen to 17%, almost exactly where it was in 1900.

Looking at the situation another way, the U.S. economy grew by an average of 3.8% a year from 1946 to 1973, right around the time when America's share of market cap peaked. Since then, GDP growth has averaged 2.7%, and the most recent decade has not lived up to even that average. From 2000 to 2010, the U.S. accounted for just 15% of total global GDP growth, less than Europe (21%) or China (23%). The U.S. share of global GDP peaked in 1985 at 32.74%. In 2010, the U.S. accounted for 24% of global GDP.

This is not to say that the U.S. will fall into some kind of severe slump, or that U.S. companies won't continue to generate profits. But it does suggest that the long, rapid run up from an emerging economy to global super-power was an extraordinary wagon to hitch your portfolio to. A long projected decline from the world's dominant economy to a market share under 20% might generate lower annual returns going forward.

A better way to say this is that U.S. investors have been spoiled by extraordinary domestic growth that helped produce extraordinary domestic stock returns not found anywhere else. If we anchor on the returns that investors enjoyed during that probably never-to-be-repeated era in the U.S., and project them forward in our portfolios, there is a strong possibility of disappointment.

So how do we want to deploy our assets in the global opportunity set, if the U.S. is mature and likely descending from its peak? Who or what is ascending? Where can we find similar growth to what the U.S. had enjoyed? And how can we position our investments to capture that growth?

Our search led to those economies that are currently emerging and what was most surprising was how rapidly this is taking place today. The term "emerging markets" was been coined in 1981, defined as countries with in-come per capita of $10,000 or less. The threshold today is around $15,000. The first EM indices seem to date back to 1995, when this obscure niche of the global economy made up 3% of the world's market cap. By the end of last year, that percentage had grown to 28%. Goldman Sachs recently issued a report that suggests that by 2030, the market cap of what we used to call emerging markets will exceed that of the traditional developed markets. Jeremy Siegel forecasts that EM countries will make up 67% of total market cap by 2050.

Turning back to GDP, during the 2000-2010 decade, China alone contributed 23% of total GDP growth, India 8%, Japan 3%, and other Asian nations 12%. For the next five years, while the U.S. is projected to contribute 13% of world economic growth, China's projected contribution is 29%, India's is 10%, Japan's is 3% and the rest of Asia is projected to contribute 11% of the world's growth. My calculator says that this makes up more than half (53%) of the world's growth coming from Asia, mostly from the less developed economies.

While China gets the majority of the press coverage, it is not the only country that is growing rapidly. According to the International Monetary Fund, by the year 2015, there will be 17 countries with an annual GDP over $1 trillion, compared with only ten today." In the first half of 2010, Asia, notably including the Hong Kong market, accounted for 60% of global IPOs, vs. 16% for the U.S.

Okay, so what do we DO with this information? Step one is to overcome our homeboy bias and recognize that much of the GDP and portfolio return growth is going to come from abroad in the years ahead. Our homeboy bias will be harder to cure because it worked so well for U.S. investors in the past well, until ten years ago, anyway; and because we probably have unrealistic expectations about future U.S. stock returns.

Step two is to recognize that what we call emerging markets are not what they were in 1995. Most of Asset Allocations in the U.S. allow only 3% of a portfolio to be allocated into emerging markets. They just assume, without really thinking about it, that our emerging markets allocation should be somewhere in that range. But if that's where the majority of the world's growth is going to come from, it needs to be a bigger part of our allocations.

Step three is to recognize that the traditional indices severely underweight the places where the growth is expected to come from. The MSCI EAFE Index allocates 66% of its weightings to Europe and another 20% to Japan. The EAFE EM Index, meanwhile, allocates just 7% of its assets to Indian stocks, and 18% to China. We have an unusually high 40% allocation to non-U.S. equities. If you have 20% of client portfolios in EAFE, and another 20% in the EM index that means your total allocation to India is 1.4%. To China (including Hong Kong): 5.2%. To other Asian countries: 12.2%.

In all, this aggressive international investor would have just under 20% of his client’s portfolios invested in the economies that are projected to generate 50% of the world's economic growth over the next five years.

Step four is to reexamine the argument that you can get all the exposure you need to international and emerging markets growth by investing in U.S.-based multinational firms. There are 5,000 companies worldwide with a market cap over $1 billion, and 75% of them are located outside the U.S. There are 25 stock markets with an average company size of $1 billion or more. Ten of these are considered emerging markets, and the U.S. is number three on that list.

Step five, it may be time to retire the term "emerging markets" altogether. "There's a real lack of consistency in how some of these countries are defined and categorized. China is the obvious example; if you look at coastal China, you see all the signs of a major economic power, a country with 1.1 millionaire households. True, many people in the interior are impoverished, but given China's importance in the global economy, and the sophistication of its technology and its overall wealth, how much longer can you say it is "emerging”? Plus, Hong Kong is considered a developed market, and China's and Hong Kong's stock markets are clearly intertwined. Half of the market cap on the Hong Kong stock exchange is made up of mainland Chinese companies.

Rethinking Allocations
Once you make all of these mental adjustments, what then? The Americas, including the U.S., Canada and Latin America make up 40% of the world's market cap. So that becomes the reference percentage you start with before making any tactical or strategic adjustments. Note that this allocation includes a number of developed markets, Canada and the U.S.; and a number of emerging economies, Latin America. Instead of drawing a lot of distinctions about how developed each country is, focus on capturing the region and its various economies.

The Asian/Pacific region currently makes up 30% of the world's market cap. Europe, which includes many developed and some emerging Eastern European economies, makes up 25%. An "other" category, which includes many Middle Eastern and African nations, currently makes up 5%.

That's the base allocation. If you still have a U.S. bias you could raise the Americas allocation from 40% to 45%. You still want to stay ahead of the strong growth in Asia, so increased the Asia allocation a little bit, up to 32%. Next you reduced the Europe allocation from 25% to 20% to make room for the slightly increased expo-sure to the Asian region. The last piece of the puzzle is to reduce Middle Eastern and African nations from 5% to 3% of client portfolios.

Another advantage is that this approach is easy to implement. Within each of the broad allocations are a variety of country-specific ETFs, plus ETFs that focus on the different regions.

There could be a problem with two very popular ETF the Vanguard Emerging Markets Index and the iShares Emerging Markets Index. Both funds are based on MSCI criteria, what happens when MSCI determines that China is no longer an emerging market? It could be a huge mess. We need to keep track of this situation, since we currently use them in our client allocations.

When you look at the years since 2000 in this larger context, the lost decade doesn't seem quite so strange any more. We are starting to experience what everybody else in the world would consider normal market returns, perhaps even subnormal since the U.S. is now on a course that is opposite to its remarkable 20th century burst from relative obscurity to preeminence.

The difference between what we have come to expect and what we can actually expect from U.S. equities may not be as enormous as the big picture would make it seem. To satisfy my curiosity, I pulled out the Credit Suisse 2011 Global Investment Yearbook, which has stock returns for various countries and regions since 1900. The real (after-inflation) growth in U.S. stocks over that time period has been 6.3% a year. During much of that century and a decade, at least the first 80years or so, the U.S. was taking global market share away from Europe; in other words, America was ascendant and Europe was being passed, the way America is now being passed by the more rapidly-growing Asian economies.