Roller Coaster Ride ’07

Autumn 2007

Our January newsletter closed with the cautionary statement that “stocks are probably due for a rest at some point this year.” Little did I know that while I was up north in August getting some rest with my family, that Mr. Market would decide to go south (rather dramatically) during the same week. I got teased about not leaving the office anymore!

News

After returning from vacation, the combination of the market volatility and the subprime mortgage mess, prompted me to send out a Mid-Quarter Briefing. Much has happened since then and as the old song goes, “What a difference a day makes.” So does a month or so in market time. In fact, time really puts these things into perspective. Let’s review the markets recent roller coaster ride from the perspective of the Dow Jones Industrial average to see just what did happen:

  • The Dow opened New Year 2007 at around 12,500,
  • In July it crossed above 14,000 and then swooned back down to 12,500 on the heels of the mortgage mess in August,
  • By the end of September, the Dow was within 105 points of 14,000 or up nearly 11.5% YTD!1

What are we to take away from all those ups and downs? 2

  1. That the market had a normal correction of > 10% in the midst of a very long bull market.
  2. That Gentle Ben and the Federal Reserve still make markets move as happened in August and then again in September as they cut rates by ½ of 1%.
  3. That watching CNBC only once a month or even better, once per quarter, would give you the same results with only a fraction of the worry.

What’s next on the horizon? Unfortunately, my crystal ball doesn’t work for the stock market and the economy, but here are some facts to ponder.

Short Term: The last three months of the year have generated nearly 2/3 of the entire total return achieved by the S&P 500 stock index in the 17 years from 1990-2006.2

Mid-Term: We are in the latter stages of an economic expansion and accompanying bull market. While the Fed may have changed how we transition from cycle to cycle, (soft versus hard landings) growth/recession cycles are still an economic reality. 3

Long Term: Rate cuts are often a signal of a weakening economy. Markets respond favorably many times initially and then falter in the following year, particularly if a recession occurs. 4

All of this reinforces the need to have a well diversified portfolio that is appropriately allocated to cash, stocks and bonds according to your risk comfort level. As I mentioned in the Mid Quarter Briefing, this is a period of readjustment where the investment landscape changes pretty rapidly. It is a time where investment professionals earn their keep, not a time to change your investment plans based on reactions to market volatility.

Ideas

Heading into the final quarter of the year, I thought it would be a good idea to review some tax saving tips that can still be done before Santa comes:

  1. Savings Plans: 401(k) maximums this year are $15,500 and $20,500 for those over 50. SIMPLE IRA limits are maxed out at $10,500 with an extra $2,500 for those lucky enough to be over 50.
  2. Harvest capital losses now: Early indications are that funds will be distributing larger capital gains this year versus last year. Realized capital losses offset all capital gains and up to $3,000 in ordinary income too.
  3. Charitable IRA contribution: If you are older than 70 ½ and have not satisfied your Required Minimum Distribution for 2007, consider gifting all or a portion of it to your favorite charity. That amount escapes taxation reducing your taxable income and fulfills the RMD requirements all while doing good!
  4. Contribute to a non-deductible IRA: If single and your income is more than $110,000 or married with a joint income > $160,000, you may contribute $4,000 to a nondeductible IRA ($5,000 if you are older than 50). The limits rise to $5,000 and $6,000 in 2008. The bigger benefit here is that in 2010, Congress lifts the limits to convert these accounts to Roth IRAs. So you would only have to pay taxes on the earnings and even those can be spread over two tax years. Roths provide for tax free income in retirement and are valuable in estate planning as heirs can inherit them tax-free.

Call us for more information and details about this unique strategy. Maybe the government will make this one permanent someday too!

Commentary

The Boomers’ Brave New World of Retirement

Have you seen the studies? Not only do American’s not save enough, but baby boomers are particularly notorious at underestimating the amount of retirement income they will need. The 2006 Employee Benefits Research Institute’s annual retirement survey found that ½ of all workers have saved <$25,000 for retirement and more that 4 in 10 of those 55 and older have retirement savings <$25,000!

Changes to retirement for the baby boom gen will begin by redefining it as they have with almost everything this group has touched. For most, retirement will be a state not a date. The term ‘working retired’ will become a practical reality for many under-savers. The workplace will also probably change to accommodate fewer younger workers and higher numbers of experienced workers needing to work including flex time and investment in additional skills training. Pension and tax laws need to change as well for older workers so they don’t get penalized for working longer.

One of the bigger challenges baby boomers face, the under savings rate, got a shot in the arm from the Pension Protection Act of 2006 (PPA). The PPA allows employers to automatically enroll workers in the company’s 401(k) and to automatically increase that workers contribution annually. The worker can however, decline both the enrollment and the increases. (See the sidebar for more details on the PPA.)

For employers it is now easier to implement 401(k) automatic enrollment for their workers while eliminating the cumbersome nondiscrimination testing. For employees, their days of indecision are over. While they still may opt out, there will no doubt be more people saving more for their own retirement and that’s a GOOD thing.

Enjoy this autumn, even if it doesn’t quite feel like fall yet. It is October after all – baseball’s only interesting month. It’s when college football is in full swing and the Bengals are… well, have a great fall season!

Greg Busch

Greg Busch, CFP
Clarus Financial LLC

1 Dow Jones Industrial Average total return year-to-date through 9/30/2007
2 By the Numbers, October 1, 2007
3 Fed Staves off Hard Landing; Smart Money 9/27/2007
4 By the Numbers, October 1, 2007
5 Financial Planning Perspectives, April 2006; Financial Planning Association

This newsletter and the ideas expressed herein are my own and is provided for informational purposes only, and does not constitute an offer or solicitation to buy or sell any security discussed herein.

Information and any statistical data contained herein is obtained from other sources which we believe to be reliable, but we do not represent that they are accurate or complete, and they should not be relied upon as such. All opinions expressed and data provided herein are subject to change without notice.

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Newsletter Archives

Autumn 2008 »
Maximum Optimist

Summer 2008 »
It’s Déjà Vu All Over Again

Spring 2008 »
March Madness

Winter 2008 »
Year In Review 2007

Autumn 2007 »
Roller Coaster Ride ’07

Mid-Summer 2007 » A Mid-Quarter Briefing From Clarus Financial

Summer 2007 » Mission Accomplished

Spring 2007 » Our Interests May Not Always Be The Same

Winter 2007 »
The Year In Review

Autumn 2006 »
FILL’ER UP

Summer 2006 »
Summer Doldrums?

Spring 2006 »
Presidential Cycle: market indicators for an uncommon 2nd term president

Ps & Qs of the PPA

The Pension Protection Act of 2006 allows employers to automatically enroll workers in the company’s 401(k) plan and to automatically increase a worker’s 401(k) contribution annually, though the employee can decline both enrollment and the increase. The provision was added in an attempt to boost 401(k) accounts, the primary vehicle for worker retirement savings.

To qualify for nondiscrimination protections, automatic (or default) contributions must be at least 3% in the first year and increase regularly. The company must also either make a matching contribution or a nonelective contribution on behalf of each non-HCE (highly compensated employee).

If the employer chooses to make matching contributions, they must equal 100% of the first 1% of compensation contributed by the employee, plus 50% of the next 5% of compensation contributed. If the employer chooses to make nonelective contributions (i.e., not based on the employee’s elective deferral contributions), they must equal at least 3% of the employee’s compensation.

If these guidelines are met, employers wouldn’t have to subject their plans to nondiscrimination testing, which essentially ensures that a company’s highly compensated employees — such as executives — don’t benefit more from a 401(k) plan than a non-HCE.

Source: The Tax Adviser