To Convert or Not to Convert?

I hate paying taxes. I know, I know. The government needs money to provide services and secure the national defense. I just hate paying taxes. You probably share my sentiments.

You will be surprised to know I am actually considering an option that would require me to pay more taxes over the next two years. For 2010, the IRS has changed the rules for conversions of traditional IRAs to Roth IRAs.

In the past, if you converted, you must pay taxes on the value of the distribution when you prepared your tax return the following year. However, for conversions processed in 2010, you can spread the tax liability over two years.

So, why would anyone want to do this? Distributions from traditional IRA accounts are taken at ordinary income tax rates. If you think you will be in a higher tax bracket in retirement, it might make sense to pay taxes now.

Presumably, you would pay less tax now than at retirement, when your IRA account has (hopefully) appreciated in value, and tax rates may be higher. Keep in mind that Roth distributions are tax free if you have had the Roth for at least five years and are over 59 ½.

There are other reasons to consider a conversion:

• Individuals who were previously ineligible to convert to a Roth because of income limits can now take advantage of the conversion option.
• You are not required to take minimum distributions from a Roth account.
• Distributions will be made income tax free to your heirs over their lifetimes.

Still, it may not be the right decision. If you think your tax bracket will be lower in retirement, then why pay more taxes now? If you have a short time horizon to retirement, it might not be worth the tax liability. Do you have cash available to pay the taxes? Using funds from the IRA you are converting or selling taxable assets to raise funds might be defeating the purpose.

Confused?  Your financial advisor would be glad to review your situation and determine if a Roth conversion is the right step for you.  Please give him or her a call.

Cristy Freeman, AAMS
Senior Operations Associate

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Do December Job Losses Mean “Double Dip”?

This morning we received a disappointing jobs report from the Department of Labor indicating that U.S. employers cut 85,000 jobs during the month of December. Since the consensus of analysts was expecting a loss of only 10,000 jobs, one can only wonder if this disappointing news means the end of positive jobs data.

As we move into this economic recovery we must remember that one piece of data does not a trend make. In fact, we have seen most indicators (leading, coincidental and lagging) improve over the last 6-9 months. When reviewing economic data, it is very difficult to make any conclusion from a single piece of data. Instead, it can be more important to follow the trend of data to get a sense of whether the economy is improving or weakening. During 2009, monthly job losses moderated substantially. Employment losses in the first quarter of 2009 averaged 691,000 per month, compared with an average loss of 69,000 per month in the fourth quarter. In following the recent trend, it is clear that the economy is strengthening.

We must remember that it is the job of the news people to shock us in order to ensure that we “tune in” tomorrow. Buried in today’s headlines, we learned that the US Labor market actually added 4,000 jobs in November rather than losing 11,000 as initially reported. This marked the first job growth in two years. This is excellent news that, along with the current trend, should indicate job growth for quarters to come.

In the early 1980’s we experienced what some call a “double dip” recession. This double dip recession was actually two recessions (Jan. 1980-July 1980 & July 1981-November 1982) separated by a period of rapid economic growth. In fact, the economy recovered so strongly from the 1980 recession that inflation forced the Fed Reserve to increase interest rates to a point that forced the economy into the second recession of 1981-1982. Let’s not forget that the economic period after the recession of 1981-1982 was arguably the strongest period of sustained economic growth in history.

This lesson in history teaches us that a slow and steady recovery may be more sustainable than a quick, inflation driven recovery. Although the trend to economic growth remains intact, the reasonable rate of change may allow the Fed to remain accommodative. This freedom could allow the Fed to raise rates when it feels the economy is stable enough to handle a tighter money supply.

Each and every one of us has either been directly affected or had a friend or family member who has been affected by the worst recession since the 1930’s. Their pain and suffering make us wish for a sharp economic recovery and strong job growth. However, we must not forget that before you can run you must first learn to walk. As long as the trends remain positive we will be running in no time.

Michael J. Ziemer
Partner

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All I Want for Christmas is Two Gold Teeth

Ah, gold. For thousands of years this metal has been prized by countless civilizations as a symbol of wealth, both as a store of value and a glittering personal adornment. Given the recent upheaval in our financial system, many people are wondering if gold is perhaps a more prudent investment than the stock market. My colleague Barbara wrote a recent blog article comparing the returns of gold versus those of stocks and bonds, and showed them to be not only inferior over the long term, but an ineffective hedge against inflation, as well.

Let’s not forget, however, that you can wear gold, and it looks a whole lot better around your neck than a statement from your advisor. I heard an interesting story on NPR’s All Things Considered about the cultural significance of gold in Iraq and its importance in the marriage ceremony. Apparently, there is an Iraqi saying that gold is both a decoration and a treasury (and in a war-torn country, the fact that it is portable is no small consideration). I also read an interesting commentary on CNN.com by economist Ben Stein (who in my mind will ever remain Ferris Bueller’s boring econ teacher in the 80s movie by John Hughes). Stein has always been a huge proponent of saving for retirement, so this article was a slight departure from the usual rhetoric when he said – get this – “Economics tells us to enjoy the life we have. Maybe sometimes the best investment is buying something you want.” Now, mind you he does NOT advocate spending money frivolously if it will mean eating cat food in retirement, but if you have saved and invested prudently it is OK to have a little fun because, in his words, “the life we have right now is the only sure thing we’ve got.”

So, you want to invest in gold? If you have a little to spend and you’re otherwise invested prudently, buy it in the form of jewelry (though the prices are at an all-time high right now). Don’t be a Silas Marner and bury it all under your floorboards – live a little, buy something pretty. ‘Tis the season for giving, after all. In fact, wasn’t it one of the gifts brought by the wise men on the very first Christmas? (Of course, they also brought frankincense and myrrh, which appear to be tree sap. Sounds to me like one was a wise man, and the other two were wise guys.)

P.S. My ring size is 5.

Happy Holidays!

Sarah DerGarabedian, Research and Trading Associate

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Super Human Power to Save

“How does anybody ever make money in the stock market?” my buy-and-hold investing father asked me. I couldn’t believe he was asking me this because he’s made a lot of money in the stock market over the last 30 years. It’s just that over the last decade, even the tried and true stock market investors are weary.

The way my dad has made money in the stock market is with two simple strategies. Save your money. Invest and be patient. First and foremost, my dad has a super-human power to save. He is a minister and chaplain and this does not add up to an enormous salary. But he has saved religiously (no pun intended) a little bit of every pay check he ever received. Most people cannot do this. It is by saving his money, that he has made money.

Secondly, once that money is invested, keep it put. This is something else that requires serious strength of conviction, particularly during 2001, 2002, 2008 and the first part of 2009. My dad asked “How does anybody ever make money in the stock market?” during 2008 when it felt like everything he’d saved was washing away. But he stayed invested and it has paid off. Despite the various market declines, the long term trend is up. For instance, when my dad starting investing in 1980, the S&P 500 index was at 107, in 1990 it was at 353. Now it is hovering around 1100, and these levels do not even consider dividends.

This is how you make money in the stock market. Even when things look grim, keep saving, keep investing. You can’t control the stock market (believe me, I’ve tried), but you can control what you do with your money. You can spend it or you can save it. Choose to save regularly. Choose to invest wisely, and stay invested. Be patient and give it time.

Harli L. Palme, CFP®

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The Importance of Dividends

The current dividend yield on the S & P 500 index is about 2%. According to a recent article in Barrons’, dividends accounted for 43% of stock market returns over the past 83 years. The remaining return came from the change in stock prices. So far in 2009, dividends have accounted for only about 10% of the market’s total return.

We believe that dividends help put a floor under the value of a stock, because you are receiving an ongoing stream of cash flows from the time that you make your investment. Growth stocks, which pay lower or no dividends, must earn their total return exclusively from the change in price.

It is important to consider both the level and sustainability of dividends. The S & P 500 has a payout ratio of about 45%. This means that for every $1.00 in earnings, companies are paying an average of about $0.45 in dividends. Significant levels of debt or off-balance sheet obligations like under funded pension plans or post-retirement health care benefits may restrict a company’s ability to pay dividends in the future, since they have other needs for this cash. When evaluating individual stocks for inclusion in client portfolios, our Investment Policy Committee considers both the current dividend yield and the payout ratio. A high payout ratio of 75% or more may indicate that the dividend is at risk of being cut in the future. An unusually high dividend yield is also a sign that the dividend may not be sustainable. If something seems too good to be true, it usually is.

Why not buy all dividend paying stocks? Different clients with different investment objectives may have different levels of dividend paying stocks. A retiree who is spending from their portfolio, in addition to possibly having an allocation to fixed income (bonds), may have more dividend paying stocks than a younger client in the accumulation phase. Increasing portfolio income is one factor that we take into consideration as we review client portfolios for potential improvements. Also, a cornerstone to our investment philosophy is broad diversification including growth and value companies, small, medium and large companies and international companies. We never know for sure what is going to do better, so we want to have a mix of assets that will perform well under a variety of market conditions. If we focused exclusively on dividend-paying stocks, we would be forced to underweight sectors of the economy like technology that we believe have attractive future growth prospects. This year, large growth companies have returned over 32% versus 17% for large value companies. Small and mid-sized growth companies have also outperformed their value counterparts during this period. Therefore, including an allocation to growth companies that pay little or no dividends has helped portfolio returns this year.

Currently, dividends are taxed at the same rate as long-term capital gains. With the Bush tax cuts currently set to expire at the end of 2010, dividends are scheduled to be taxed at higher ordinary income rates for 2011 and beyond. The main implication of this from an investment perspective is asset location. If the tax on dividends does rise, we would lean towards putting higher-dividend stocks in a tax-deferred account such as an IRA where feasible.

Bill Hansen, CFA
November 25, 2009

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ORGANIZE! ORGANIZE! ORGANIZE!

Are your affairs in order if you died tomorrow? Is your will or trust up-to-date? Do you have the assorted legal documents all in place: healthcare power of attorney, durable power of attorney? Have you checked the beneficiaries on your retirement accounts lately? Be Prepared – isn’t that the Boy Scout motto? We have seen clients with five or six separate IRA accounts or brokerage accounts at various places. Combining like-type accounts is much simpler and certainly less paperwork. Do you have old stock certificates lying around? If you would deposit them now into your brokerage account you will save your beneficiaries much time and trouble. Do you have a safe deposit box? We have seen clients that have had multiple bank accounts and more than one safe deposit box. Your beneficiaries need to know where to find the paperwork that leads them to your various accounts, certificates and safe deposit boxes. I recently had a client die and his daughter found a notebook in his residence with detailed instructions on where everything was, including a map of downtown Asheville with instructions on how to find Parsec Financial. You might also consider checking on your parent’s situation (if they would permit that).

Barbara Gray, CFP®
Partner

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The Holidays Are Approaching!

Can you believe it is November already? The holiday season is fast approaching, a time when everyone is frantically looking for gift ideas for loved ones or considering year-end charitable giving. Have you considered giving highly-appreciated stock this year?

I will give you a minute to catch your breath from laughing. Yes, some people still have it, even after the market meltdown. You could certainly sell some of the stock and offset the gains with losses you are carrying over from last year. You might also consider it for gift giving.

A gift of stock to a minor can lead to valuable lessons about investing and financial responsibility. Just ask our founder, Bart, and his wife, Elaine. If their children wanted the hottest sneaker or the latest video game, they had to use funds from dividends on stocks they owned. Mom and Dad were not an ATM. Their children learned good money management skills, which is something everyone could use.

No, I am not trying to score brownie points because year-end reviews are soon. Kids learn a lot when they have a vested interest in the activity.

Also, charities would welcome a gift of stock. You must have owned the stock longer than one year. You can claim a tax deduction on the value of the stock at the time of transfer. You will not incur a capital gain, as long as you give the shares, not the proceeds from a sale. You will incur a capital gain if you sell the shares first.

Of course, there are tax issues, exclusions, and other requirements, depending upon the type of gift. If you have a particular stock you would like to give, please contact your financial advisor.

It is important to process the transaction early. The later you wait in December, the harder it is for brokers to complete the transaction before year end. Besides, with all the chaos that surrounds the holiday season, wouldn’t it be nice to cross off one thing on the to-do list as soon as you can?

Now, let’s all take a deep breath and prepare ourselves for the madness to come. I hope everyone has a safe and happy holiday season.

Cristy Freeman, AAMS
Senior Operations Associate

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Who Says it isn’t Easy Being Green?

Well, I finally broke down and invested in a socially responsible mutual fund. I don’t know what’s happening to me – I’m starting to have feelings, a conscience – and I was so convinced that I’m perfectly logical. I blame it on becoming a parent. I’m suddenly much more concerned about how companies are making profits, rather than just if they are. And apparently, I’m not the only one – socially responsible investing (or SRI) has been around for over 250 years, beginning with early religious proponents such as the Society of Friends (a.k.a., Quakers) and John Wesley. Though the objectives of some socially responsible mutual funds are still rooted in religious principles, most are now concerned primarily with environmental sustainability and corporate governance. A mutual fund (or fund company) with socially responsible objectives screens its investments both for elements it doesn’t want (business practices that are harmful to individuals or the environment) and for elements it does (clean technologies, ethical business practices, respect for human rights).

Finding out the objectives of a particular socially responsible fund is a relatively simple matter of searching for the fund company online – they usually list that sort of information on their website. (Well, I say simple, though recently my computer was infected with a virus that attacked my search engine of choice. I noticed something was amiss when Google was all dressed up for Thanksgiving – on October 12th. After glancing at my calendar to make sure it wasn’t already the fourth Thursday in November, I saw it was Thanksgiving – in Canada! The virus was redirecting me to Google Canada, for some reason, as well as to malware-loaded sites, but our IT folks got me all cleaned up.)

In this article I’ve focused mainly on mutual funds, because with individual stocks, it’s easier to pick and choose the companies in which you’d like to invest. When you buy shares of a fund, though, you are buying a basket (sometimes hundreds) of individual companies, and it’s hard to know what you own, since you are in effect paying the fund manager to choose the investments for you. However, you can find a socially responsible fund that screens companies for the qualitative measures that are important to you, a process for which they are much better equipped than the typical individual investor. And, with SRI accounting for about 11% of the US investment marketplace (according to socialinvest.org), it’s getting easier to find funds with good track records and reasonable expenses. 

So, what’s the main takeaway here? That apparently, Canadians celebrate Thanksgiving, too. Not that there’s anything wrong with that, eh?

Sarah DerGarabedian

Research and Trading Associate

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When Mutual Funds Make Sense

The best thing about mutual funds is that they are an easy way to hold a diversified investment.  The difficult thing about mutual funds is that many mutual funds underperform the broader market, they can be expensive, and there are so many options available that picking among them can be daunting.  But it is possible to pick high quality, low expense mutual funds that are suited to you, and it is important to determine when a portfolio calls for them.

It is our philosophy that in large portfolios, mutual funds are best used to get exposure to international, small-cap, and some mid-cap companies.  This is because the universe of international and small companies is so large, it is best to rely on an active manager who specializes in those areas.  Also, research and financial data is not as readily available on international and small-cap stocks, making active managers all the more important. 

We do believe, however, that we can create a well-diversified portfolio of large-cap, domestic (S&P 500) companies by buying individual stocks.  There is a plethora of research available on these companies, making financial data transparent and easy to obtain.  The trading costs on individual stocks is low enough that this is a more cost effective way to get exposure to this area if your portfolio is large enough to fit 30-50 individual positions of a reasonable size.

In smaller portfolios it becomes less cost effective to buy individual stocks.  To get 40 individual stocks in a portfolio that already encompasses bonds, international and small-cap funds, we would need to resort to very small position sizes.  The smaller the position size, the larger the transaction cost as a percentage of the holding.  Therefore, we believe that depending on the size and the number of accounts within a portfolio, mutual funds may be the best option.

When we choose mutual funds we look for those of the highest quality.  We focus on long-term performance track records, various risk measures associated with the funds, and low-cost investments.  We routinely assess the quality of the funds we hold, and screen for new additions to our fund buy list.  If a fund no longer meets our criteria, we will replace it with a fund we view as better.

To what extent a client has mutual funds in their portfolio is determined on a case-by-case basis.  Sometimes this comes down to client comfort level and perspective.  Other times it is a function of the type and size of accounts in a portfolio.  We work with clients to determine what makes the most sense for their particular situation.

Harli L. Palme, CFP®

Financial Advisor

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Inflation Ahead?

With the extraordinary amount of fiscal and monetary stimulus pumped into the financial system over the last 12-18 months, many investors are concerned with the prospect of future inflation. The large U.S. budget deficit is another potential inflationary factor if it is financed by the government expanding the money supply.

Despite these factors, inflationary expectations in the bond market are quite low. There is even a small but vocal minority of market participants that believe that deflation remains a significant risk. One way to determine the markets’ expectation for inflation over the next ten years is to compare the yields of U.S. Treasury Notes against those of Treasury Inflation Protected Securities (TIPS) of similar maturity. The current yield on the 10-year U.S. Treasury Note is 3.33% as of this writing, while the 10-year TIPS yield is 1.5%. The difference of these two numbers is the implied inflation rate over the next 10 years of 1.83%. If inflation over the next 10 years turns out to be higher than 1.83%, then you would be better off buying the inflation-protected security. Since 1926, inflation has averaged about 3% annually. While we do not believe that there will be a sharp increase in inflation over the next 1-2 years, it certainly is a possibility over the longer term. Therefore, within the fixed income allocations of our client portfolios, we have been avoiding purchases of traditional Treasury securities in favor of TIPS.

 What asset classes would perform better in an inflationary environment? Among fixed income investments, we would expect inflation-protected bonds and high-yield bonds to perform better. Although the short-run impact of inflation on stocks has historically been mixed, stocks typically act as a hedge against inflation over longer time periods. This is particularly true of companies and industries that have the ability to pass along price increases to consumers, or those that have comparatively low levels of fixed assets. Our core strategy of broad diversification and no market timing would remain unchanged, whether the environment is inflationary or deflationary. The main determinant of a portfolio’s return is the asset allocation. Having the discipline to stick with your chosen allocation is more important than the specific allocation that you choose.

Within the equity portion of client portfolios, we may overweight certain sectors or industries that we believe would fare better in a particular inflationary environment. However, since the future is uncertain, our main goal remains to create client portfolios that will perform well in a variety of economic scenarios.

 Bill Hansen, CFA

October 9, 2009

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