Letter to Our Clients - January 2010
Dear Clients and Friends:
A. Neither a Pessimist Nor an Optimist Be
“The error of optimism dies in the crisis, but in dying, it gives birth to an error of pessimism.
This new error is born not an infant, but a giant.”
Arthur Cecil Pigou (Economist, died 1959)
Back in January, 2000, once Y2K had passed, we were all optimists. We thought we were in a “new normal” of constantly improving equity prices. Then March 2000 started the worst bear market since 1973-75, and we were educated that the old normal still applied.
In the Fall of 2002 and into the Spring of 2003, there was no apparent reason for hope. And yet began a bull market that lasted into the Fall of 2007. At that point everyone on Wall Street, and most investors, were optimistic about the long-term benefits of tax cuts, low interest rates and the health of the global economy. Yet the stock market suffered through the worst bear market since the Depression of the 1930’s. Then in March, 2009, when there was no good economic news to be found anywhere, the markets moved up again. We ended up with 2009 being a better-than-average year for stock market performance.
Most of the 2009 market return was generated by institutional investors. “Retail investors,” people like you and me, have been sitting on the sidelines, waiting for confirmation that the economy is better and that it is “safe” to invest. There is good news and bad news in that.
The good news about retail investors missing most of the upturn is that there is likely (but not guaranteed) more upside to go – no matter how you feel about the unemployment rate or current politics. The bad news is that, probably, most of the “easy” short-term gain is gone.
Now let me get to the point of the headline. Market forecasting is less predictable than weather forecasting. Basing investment strategies on what we think the economy or the financial markets will do make us feel like we know what we are doing, and it can give acceptable results some of the time. The problem is that the forecasting is not actually predictive of the result – most likely it is just coincidence. And, the result of being wrong is missing major market turns, what we call inflection points. Examples would be early 2000 and the Fall of 2007 for market highs, 1982, 2003 and March 2009 for market lows. However, this inability to forecast successfully has been a human characteristic for as long as people have been investing in risk-based assets.
I have referenced “behavioral finance” before. Attached is an excellent graphic from the American Funds illustrating investor psychology. It points out how difficult it is to sell when values are growing, or have hit recent highs, and how difficult it is to buy when prices have dropped. The key to long-term success is to ignore the impulses of optimism or pessimism, and instead design a strategy which gives the growth opportunity that is consistent with one’s ability to tolerate market fluctuations.
This is possible if you can balance the chatter of talk radio, talk television, newsletters and the expert opinions from acquaintances at work or at parties. Commercial outlets are angling for profitable listeners or subscribers, so they say what they believe will sell. Private individuals may be sincere in their beliefs, but they have their own agendas, experience, biases and goals, none of which are likely to match yours. Only you are able to make decisions that are in your best interests.
B. The Benefit of Roth Conversions
Speaking of chatter, the financial news is full of advice about how wonderful it is that we can convert traditional IRA’s to Roth IRA’s.
Up through 2009, you could not make this conversion if your Adjusted Gross Income was over $100,000. Now everyone, regardless of income, can convert, and this is not a one-year option. The income ceilings are gone, at least until Congress changes the rules again.
Remember, though, the amount converted from a traditional to a Roth IRA is taxable income for the year of conversion. For 2010 conversions only, the tax can be spread over two years, to be paid in 2011 and 2012. Nevertheless, the tax is still payable.
This can be a useful tool, given the right circumstances. For those with incomes under the thresholds, the excitement is irrelevant. You can still convert any time. For those with incomes over the thresholds, it is a great planning opportunity but it may sound more attractive than it really is. (My cynical opinion is that the financial services industry is pushing this in hopes of putting money in motion, thereby generating sales that would not otherwise come into play.)
Whether to convert a traditional IRA to a Roth IRA should receive serious consideration, especially if you anticipate a tax year with less income than normal. We will try to mention it whenever we review your accounts. If we forget please bring the topic to our attention. Even if it is not an appropriate strategy in any given year, it may be attractive at some future point.
The last 10 years have been, well, challenging. I suspect the next 10 years will be equally challenging, but probably in different ways. Life keeps changing on us, and what is hardest to accept is that the pace of change continues to accelerate. But with good planning, and some luck, and with a long-term optimistic life perspective, we can prosper. We would like to be a part of a successful next decade with you. Best wishes for 2010 and beyond!
Thank you again for the opportunity to work with you.
Robert K. Haley, JD, CFP®, AIF®