June 15, 2010

Scotland, Land of The Frugal

Every so often I get to write a newsletter from a really unique place.  Today, it is the high speed train linking London with Edinburgh, as I make a pilgrimage to Shapinsay in the Orkney Islands off the northern coast of Scotland, the ancestral homeland of the Hepburn’s.

How my family ended up in the Orkneys is a rather colorful story involving James Hepburn, the Fourth Earl of Bothwell (a Protestant) and Mary, Queen of Scots (a Catholic) who were married, briefly.

Things did not end well for the Hepburns, particularly the Earl who was arrested for the scandal that such a mixed marriage could create back then – and other assorted sins – and was spirited away to Denmark where he died in prison.  Of the Hepburn clan, only the swift and the clever survived the purge that followed, and they fled to the out-of the-way Orkneys.  Personally, I inherited excellent running skills.

Anyway, I love the technology that allows me to work from far off places, as though I am sitting at my desk in Prescott.

I’ll be back home next week with lots of stories.

Decision Time Regarding Roth IRAs

The Investment View from Prescott, Arizona

IRA owners have an opportunity to convert their Traditional IRAs to Roth IRAs, which may not be available after this year.  The decision to convert will be different for each of us, but I would recommend you make your choice soon, as I expect a year-end rush that might overwhelm processing centers.

Roth and Traditional IRAs both enjoy tax deferred growth, but are very different in other tax treatments.  

Traditional IRAs are usually funded with untaxed (deducted) dollars, but money coming out is taxed as ordinary income.  Roth IRAs are funded with already taxed dollars, but the money coming out is income tax free.   

Roth owners are not forced to take required minimum distributions at age 70.5, either. So there are multiple benefits to a Roth.

The big drawback to making a conversion to a Roth is that money coming out of the Traditional IRA must be taxed before going into the Roth. (Remember, Roth’s are funded with already taxed dollars.)  The amount of tax you have to pay will depend upon your existing taxable income and the amount coming out of your IRA for conversion to the Roth.  Your tax preparer should be able to give you an estimate of the tax impact and then you can decide to convert part, all, or none of your IRA.

Another benefit of converting this year is that you can pay the taxes at this year’s tax rates, but do not have to pay until 2011 and 2012, half each year, rather than having to pay them all right away.

Four factors that can make a Roth conversion profitable for you are:

1.    Tax Rates:  If your tax rates will be higher in the future your tax savings will be greater than what you pay now.
2.    Time:  The biggest benefit of all from IRAs comes from the tax deferred build up within them over long periods.  The longer you can leave your money in the Roth the greater your benefit becomes. Can you leave it in for a long time?  If not, the conversion is worth less to you.
3.    Can you pay taxes with other money?   If you have to pay taxes from your IRA money you won’t have as much going into the Roth and your benefit from converting becomes smaller.
4.    Investment returns:  If your investments go up, which no one can guarantee, all of your gains avoid income tax.  However, if they go down you will have already paid tax on money you later lost.  

Don’t delay if you want to do a conversion to a Roth IRA.  Avoid the year end rush.

Riddle:

Q: I have hands that wave at you,
Though I never say goodbye.
It’s cool for you to be with me,
Especially when I say, “HI.”

What am I?

A: An electric fan

What we were saying back then

In my April 20, 2010 newsletter I wrote “One tenet of socio-economics is that the icons of success in a bull market, such as we had in the 1980-90s, will all be pulled from their pedestals during the bear market phase which follows”.

To back up the theory in that article, I mentioned the painful declines of marquee names like AOL, Fannie Mae, Merrill Lynch, Goldman Sachs and Alan Greenspan.  

The latest tarnishing of a reputation due to the socio-economic decline underway is Mr. Clean himself, Warren Buffett.  

Testifying in front of Congress, Buffett was asked whether, as the largest shareholder of Moody’s bond rating service, he felt any responsibility for the 2008 credit crisis which was caused, in part, by the credit agencies’ botching of the credit worthiness ratings on mortgage backed bonds.  

His denial was met with “universal derision” according to writer Felix Salmon.  

When you hear the words derision and Buffett in the same conversation, you can be sure that the times, they are-a-changin’.

How’s the market doing?

The stock market in general is being racked by uncertainty over credit issues in Europe.  With luck, those issues won’t spill over into the US markets, but no one knows what will happen, so nervous investors have been reducing exposure to risk over the past two months.

The market has stabilized over the past few days, but it is too early to call this a change in trend.  The smart thing to do is watch to see what the texture of the uptrend looks like.  The decline from the April highs was much more than was necessary to work off the excess of the strong market earlier this year, but if it is over, it is over.  Right how it is too early to tell, however.

We are back to a high risk environment, so I think it is wise to be patient and not become reckless in our investing.

What’s Going On In Your Portfolio?

There have been very few changes in our portfolios over the past couple of weeks.  We still hold between 50-60% cash in Careful Growth* portfolios and even more cash in Flexible Income* portfolios.  

We have gold in both growth* and income* portfolios, along with an inverse government bond funds that will profit if interest rates start to rise.  

Our Careful growth* accounts hold two stocks, one of which is at an all-time high despite the markets weakness, and the second stock was also at an all time high just a day or two ago.  

Although I can trade adequately from over on this side of the pond, there is not much in a consistent enough uptrend to make me want to invest right now.    If the market continues to firm up, this could change, but right now I am being pretty conservative.

Our Spotlight Strategy

Our Strategy Summary sheets have performance data updated quarterly for posting on our web site.  We will publish them here in the Spotlight Section of the newsletter at the beginning of each quarter when the data is fresh.

However, since I have two main strategies, Flexible Income* and Careful Growth* (three if we count Balanced* which is a 50/50 blend of the two), and there are seven publishing dates this quarter, we do not publish performance summaries in every newsletter.

Our Municipal Income* strategy is run similarly to Flexible Income*, just focusing on income tax free municipal bonds.  The Socially Responsible Investing* (SRI) strategy follows the Careful Growth* model but uses a much smaller universe of socially screened investments.  

Even if we publish Summaries of these two, also, we will have a few issues where we do not spotlight a particular strategy.   This is one of those newsletters.

Instead, let me use this space to review the use of the term “model” or as I often call it, the “strategy”.  For practical and privacy reasons, I cannot speak about individual accounts, and will always refer to the model account for a particular strategy.  

Models are the templates we strive to have each account follow within the practical constraints of the business.   All you have to do is be aware of which strategy applies to your account(s).

As an example, let’s assume that my objective is for you to have 10% of your account in gold.  The type and size of your account will affect how I get you exposure to the gold market, or if I can get it for you at all.

Often I will buy an exchange traded fund (ETF) that holds physical gold bullion.   That type of investment has a $17.95 charge to buy and another $17.95 to sell.  On larger accounts, the drag on performance from these charges is negligible.  

On smaller accounts, it may be more cost effective to instead buy a traditional mutual fund that owns the stocks of gold mining companies and has no transaction fees.

Some accounts, such those held at variable annuity companies, may not offer any gold related investments at all.  

For these reasons, individual account performance may vary from what is reported for the model portfolio.  This is also why I speak generically in this newsletter about investments we own in your accounts – I frequently use different investments to pursue the same objective.

Performance numbers are generated using a hypothetical $100,000 account, and will be affected differently by the proportions of fixed trading costs ($17.95) for larger or smaller accounts.

I always apply my maximum (2.5%) management fee for performance calculations, so performance numbers reflect the net gain you would have seen during that period after deductions of all fees and expenses.  Due to volume discounts and family and friends group discounts, you may have lower fees. This can also skew your performance away from the model performance.

There are many issues affecting performance reporting.  I try to do mine as fairly as possible, and with this explanation I hope you will understand if there are differences between the numbers I report and those you see reflected on your statements.

Just let me know:

As a client of mine you may know me as an investment manager, but I have years of related experiences to draw upon.  Just let me know if there is anything else I can help you with.  Membership has its privileges, you know.  The only thing I ask in return is that if you have any friends that could use my services please think of me.  I’ll treat them as I have treated you.  That is the way I do business.

*    The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed.   Activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account.  Not all trades are profitable.  It should not be assumed that current or future holdings will be profitable.   A list of all trades in these accounts for the past 12 months will be provided upon written request.

**  The S&P 500 and Nasdaq Indexes are unmanaged lists of stocks considered representative of the broad stock market.  Investors cannot invest directly in the S&P 500 Index.

Balanced Strategy Description and Performance Information
Careful Growth Strategy Description and Performance Information
Flexible Income Strategy Description and Performance Information

This newsletter may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Information in this newsletter may be derived from sources deemed to be reliable, however we cannot guarantee its accuracy.  Please discuss any legal or tax matters with your advisors in those areas.  Neither the information presented nor any opinions expressed herein constitute a solicitation for the purchase or sale of any security.