A Word From Robin
March 2003

by Robin Sherwood

 

Market Advice

As I prepare this newsletter, we are all anxiously waiting for a resolution to the Iraqi situation. There is no question that the American public is on edge in terms of spending, traveling and investing. Many are questioning whether they want to be invested at all.

The numbers indicate that the economy is growing slowly (+2%/yr), inflation is under control (1.6%/yr) and orders for durable goods, a sign of demand, are up. On the negative side, unemployment is rising, oil prices are up and consumer confidence is at the lowest level in a decade. What's an investor to do?

The unanswered question is whether a resolution to the Iraqi situation will turn us around. My feeling is that confidence is a big factor, but not the only factor. While a positive resolution to Iraq will probably buoy the market in the short-run, it will be the economy that propels it in the long run. Again, what's an investor to do?

I do not believe in a blithe, 'stay the course' attitude. First, you've got to determine that your course is a well thought-out one, and then figure if you want to hold on to it. Second, you need to recognize a move away from equities is a move to a lower returning vehicle, namely bonds. A lower return will require more savings and perhaps, more sacrifice. Bonds pose risks, especially in light of higher deficits and re-inflation but then again, risk is everywhere.

Everyone needs income and growth. The question is in what mix and how much you can afford to lose and/or not gain. The answer to this question is part financial theory and part emotion. No single answer is correct.

The reality of the past several years is that we all may need more safety and security than we thought. Having said that, beware of focusing too much on the immediate future, and ignoring the longer- term future. You may buy short-term safety and long-term risk.

Warren Buffet recently announced he feels stocks are still overvalued and he's not adding to his investments at this point. He's staying the course because he knows that over the long run, well- managed businesses are still the best investment.

As I've mentioned to my clients in the past, most retirees will be comfortable with a balanced mix of stocks and bonds. That mix may range from 50/50 to 25/75, depending on individual needs and circumstances. As in life, one size rarely fits all.

Will Dividends Be Tax Free?

On January 14th, President Bush proposed a partial end to the double taxation of dividends paid by certain corporations. I say 'partial' because not all dividends will be exempt.

Dividends from companies not paying tax will not be exempt and other special types of companies like REITs will not be exempt. Most importantly, dividends earned within pension plans, IRAs, Keoghs, SEP-IRAs, 401Ks, Life Insurance & Annuity Accounts will not be exempt. It has been estimated that over 65% of total equity ownership is in these accounts and other nontaxable accounts such as Endowments, Foundations and Pensions. All of these will be unaffected by this proposed tax policy.

The proponents of this plan assert that stock held in exempt plans will benefit indirectly as the stockowners affected (35% of the total) bid up the prices of all equities in search of tax-free dividends. Tax sheltered plans still won't receive the tax-free dividend. And, some economists question whether this will happen and to what degree. One might ask what impact this would have on municipal bonds that will compete directly with tax-free dividends.

Finally, an exemption for dividends not paid (deemed dividends) is proposed, so that companies not paying a dividend receive equal treatment. While conceptually this is desirable, from a practical standpoint it would be an accounting nightmare.

My view is that the end to double taxation is the right goal, but we should seek to exempt all dividends equally and within a simple, understandable system. Adding complexity to our tax system is not in our best interest.

We'll certainly hear more debate on this issue before it is resolved.

Should You Contribute to an IRA?

This is a good question that is often overlooked. Annual contributions are now $3000 per year and $3500 if you're over 50. Some workers don't think they are eligible, but all workers are eligible if they make a minimum of $3,000. However, tax deductibility is limited. Here's a quick look at eligibility:

Traditional IRAs: You can make an IRA contribution if you have earned $3,000 or $3,500 if over 50. The contribution may be deductible if your Adjusted Gross Income (AGI) is under $34,000 (single) or $54,000 (married). Check with your tax preparer before making the contribution.

Roth IRA: If your AGI is under $150,000 (married) or $95,000 (single) you can contribute to a Roth IRA. While it does not provide an immediate tax deduction, the Roth offers tax-free interest and growth forever.

Roth Conversion: If your AGI is under $100,000 you can consider a conversion from Traditional IRAs to a Roth. Beware of the tax cost of a conversion.

An IRA Gift. Can't make an IRA contribution? Consider making one for your working child, as a gift of retirement savings.

On Being a Financial Planner

I am well into my second decade of offering financial planning advice and I find that I am perpetually challenged to find new solutions for my clients. I wonder if the financial planning world will ever slow down.

Today we are facing the fourth year of declining stock prices, and while I am hopeful that the end is in sight, clients rightfully demand new answers. The world we live in today compounds in complexity at a rate previously unheard of. At the risk of being outdated before the ink dries, I'll share my new and old ideas.

First, what's old?

While I've said this to our clients many times, it bears repeating: A laddered bond portfolio is a beautiful thing. In a rising rate environment it allows for a gradual increase in income and in a declining rate environment it protects from sudden income changes.

As wonderful as a taxable bond ladder is, a municipal bond ladder for those in the 27% plus tax bracket is even sweeter.

If I were to write a recipe for the perfect retirement portfolio, it would be

• 1 Large Measure = Municipal or Corporate Bond Portfolio 2-12 yrs
• 1 Large Measure = Portfolio of Dividend Paying Stocks
• 1 Extra Large Measure = an IRA Balanced between Bonds and Stock

Now, what's new?

I'm increasingly convinced the financial planners need to get more involved in structuring annuity life streams of income. This downturn has taught us that we all need a base of income that does not vary with investment/economic times. More volatile income streams can be layered on top on the base.

What can provide this if we don't have a company pension? A fixed or variable annuity can. These products have been predominantly sold as accumulation vehicles with little concern for the distribution phase. As accumulation vehicles they are weak due to high expenses and disadvantaged tax rates (i.e. ordinary income versus capital gains). As distribution vehicles, they may be our answer.

For example, today a 70 year old can take $100,000 and convert this to a $750/month or $9000/year stream of income. While this looks like a 9% return, it really isn't, since the asset evaporates at your death (or death of joint annuitant). While it isn't appropriate for all your assets, it serves as a base of income.

A variable annuity is like a fixed annuity, but the monthly payment varies up and down with the investment performance. This type of annuity will provide a lower level of income with the prospect for gradual long-term increases.

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