Letter to Our Clients - January 2004

January 2004


To My Friends and Clients:

2003 turned out to be a good year for both the economy and the stock market. Why did 2003 turn out so well, given the gloom at the beginning of the year? The economy was clearly helped by historic low interest rates, an expansionary monetary policy, and tax breaks which were especially meaningful for businesses and investors. In addition, the dollar’s decline against foreign currencies, which many feared would harm our economy, so far has proved to be a blessing to those industries who sell overseas, and hence to the market overall. Once the war began in March, the “wall of worry” seemed to fade away and the stock market rocketed upward.

All of the positive factors are still in place and would seem to indicate that the economy should continue to grow. In addition, this is a presidential election year, so the administration has tremendous incentive to provide as much impetus to the economy as possible. This should result in another positive year for stocks, but we know better than to be overconfident.

Because of the low interest rates, money market accounts, certificates of deposit and other cash equivalents are generating what are called “negative real rates of return,” that is, they are not keeping pace with inflation and taxes. Most “experts” believe the Federal Reserve will not raise rates until after the November elections but will increase rates shortly thereafter, not good news for bonds. Real estate may provide positive returns going forward but the large gains of the past are not likely to continue. The stock market appears to be “fairly valued” at this point, which means growth should come if earnings continue to rise, but, again, the large gains of 2003 may not repeat. On the other hand, no one predicted the dramatic increases in 2003! So, what are we to do?

For those dollars which will be spent in the next two years or so, one must accept either certainty and minimal returns (“negative real returns”), or higher potential returns with the risk that the investment will be worth less when needed in the future.

For those dollars available for investment, that is, where the goal is to grow principal and/or to use principal to provide income, we suggest two strategies to consider.

A growth portfolio can have different levels of aggressiveness. I caution anyone who believes their account should be able to generate 50% in a year or 15% or more on an annual basis. Such a strategy may work for a time, but it is very difficult to recognize when it is time to lock in the gain and become more conservative. I recommend instead that portfolios should be structured to be balanced between growth investments (more aggressive) and value investments (more conservative), with a mixture of large companies, mid-sized and small companies. I feel strongly that it is prudent, and not “risky,” to have 15% to 25% of one’s investment mixture in international stocks or bonds (and I prefer stocks at this time). I believe that there are opportunities in every major industry sector, even utilities, and that it is prudent to have some participation in all of these sectors. For 2004, I personally believe those sectors with the greatest growth potential are technology (again), financial, industrial materials, and energy. (Many “experts” feel Iraq will stabilize and oil prices will drop in 2004, which would be bad for energy stocks. Even if they are correct, I believe energy prices will rise worldwide as long as economic expansion continue, and that natural gas is in a “sweet spot” in the industry.)

A “moderate” growth account, and those portfolios where there is a need to withdraw money on a regular basis, should benefit by the use of high-dividend stocks, and my definition of “high” is 3% or more. The new tax law reduced the rate on most dividends to a maximum of 15%, the same as for capital gains. The result is that a dollar of dividend can be 40% to 60% more tax efficient than a dollar of interest, depending upon one’s tax bracket. This tax benefit is especially appealing if there is a higher “gross” rate of return on a stock than on a bond or certificate of deposit.*

Many predict that over time investors will reward those companies which pay a dividend, and this should result in higher stock prices for these companies. If so, then firms with no or little dividend payout may change their policy. Already we have seen a significant number of companies initiate (Microsoft) or increase (Intel) dividend payouts. This trend means that a high-dividend investment strategy could deliver acceptable returns in three ways. First, if investors favor these stocks, then prices could rise. Second, the dividend yield will generate cash flow which can be used for reinvestment, or for distribution to supplement income needs. Finally, since most dividend-paying corporations are those with strong balance sheets and strong cash flow, then it is also possible that reasonable growth can be coupled with better risk against a dramatic downturn in values.

Of course, nothing is certain. Investors who cannot afford to have their money “at risk” of fluctuation (read “going down”) must invest for safety. As mentioned earlier, this “guarantees” the loss of purchasing power. Perhaps worse, however, is the fact that these investors face the prospect of not being able to ever build enough wealth to enjoy financial stability, especially when work is no longer an option. On the other hand, investors who decide for greater income and/or growth must be willing to accept fluctuating account values.

We remain committed to helping you be clear about your financial objectives, and to helping you manage your investments to achieve these objectives. One of the ways we do this is to avoid as much as possible those investments tainted by scandal or, in our opinion, potentially subject to it. This is why I prefer to work where I am compensated by fees for my planning services and investment management. When there are no commissions it is easier to see that you and I are both working toward a common goal – your financial health. In those areas where commissions cannot be avoided, we always try to bring the issue to your attention, help you understand your alternatives, and let you make the decisions that feel best for you.

As always, please be sure to call to schedule an appointment if you have questions or concerns about your accounts, or if it is time to review your situation to determine whether your strategies remain appropriate for your current situation and your financial goals.

Thank you again for the opportunity to work with you.

Best wishes,

Robert K. Haley, JD, CFP®


*Unfortunately, Real Estate Investment Trusts (REITs) do not receive this preferential treatment, but in many cases their dividends are high enough (6% or more) that the after-tax yield is still attractive. If you would like to know why REITs do not qualify, feel free to call.