Dion Money Management Blog   Money Management for Retirees and Their Families

After a tough week of earnings announcements, stocks held their ground and even advanced slightly; the S&P 500 Index closed 2.13 percent higher than last Thursday’s close. Earnings and news from Caterpillar caught the attention of investors earlier this week. The capital equipment producer announced it would layoff nearly 20 percent of its workforce and this morning the company announced further job cuts, putting the total at more than one-fifth of all employees. As an economically sensitive global company, the news disheartened investors who hoped that the emerging markets would fare better than the U.S.

One positive sign this week was the 4th quarter GDP number released this morning. It showed the economy contracted at a 3.8 percent annualized rate, well below expectations of 5.5 percent. Meanwhile, economic data from Europe and Japan show conditions worsening. Japan’s manufacturing production fell almost 10 percent and unemployment rose to 4.4 percent. The Japanese yen, along with the U.S. dollar, has appreciated in the past six months, but this hurt exporting Japan far more than the importing United States. In Europe, inflation decreased and unemployment increased, and this led the euro lower against the dollar. Europe’s central bank has maintained higher interest rates than the U.S. for a year-and-a-half in order to combat inflation, but it’s becoming clear that inflation is the least of their worries.

It is not surprising that investors are increasingly risk averse after the unprecedented economic and financial events of the past 12 months. Even those with longer time horizons have become acutely aware of the market risk that even diversified stock and bond funds contain. In devising the asset allocation for client portfolios, I begin with high-quality funds available on Fidelity’s and Schwab’s institutional platforms and tailor an asset allocation mix in line with its stated objectives.

This year I have been on the lookout for funds that have weathered the most recent volatility well, not merely with good performance, but by managing risk in a disciplined manner. ETF Market Opportunity fund (ETFOX) is one such mutual fund (formerly Navigator Fund, symbol NAVFX), and I am pleased to introduce this fund to certain client accounts beginning today.

I am always happy when I discover high-quality managers that allow their investors access and are receptive to a thorough review of their investment process and philosophy. ETFOX has distinguished itself as an innovator by using ETFs within a large-cap growth mutual fund, applying a systematic approach to security selection with less risk. This fund has earned a five-star rating from Morningstar, and it ranks in the top one percentile for one-year returns within its category. ETFOX also garnered distinction of Lipper Leader for Preservation of Assets from Lipper Fund Services.

Finally, Fidelity Investments has informed us that they applied and received approval for an IRS extension for 2008 Tax Forms. Their new deadline for providing tax information is March 2, 2009. This may not affect all account holders, but it is best to expect a possible delay.

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Last week the rally appeared to have ended, but we received clear confirmation this week after domestic and international markets fell further. The worst selling coincided with an historic presidential inauguration, and stocks have traded sideways from there. Economic weakness caused the initial drop in shares, and negative earnings announcements did not help either, but overall the market was in good shape until Citigroup detailed a breakup plan and Bank of America asked the Federal government for more bailout money.

On Monday, banks in the U.K. plummeted on nationalization fears, and when American markets opened on Tuesday, the financial sector plunged. State Street, the issuer behind the popular SPDR ETFs, led the market down with a 59 percent drop after the company reported higher than expected losses. The firm had been a relative outperformer before yesterday, but investors quickly lowered their expectations.

Not all companies are missing the mark, however. IBM helped the tech sector rally after it reported higher earnings and raised guidance for 2009. Northern Trust beat earnings and revenue estimates, a rare occurrence anywhere these days, but especially in the financial sector. Its conservative approach and primary focus of managing money allowed it to steer clear of the troubles plaguing the larger investment firms acting like financial supermarkets. Apple beat its estimates, but Microsoft missed its own, sending their stocks in opposite directions this morning.

The economic data continues to paint the picture of a substantial recession, but there is a good chance that the worst is behind us. Although jobless claims rose and housing starts declined  this week, there were seasonal factors to account for the unemployment figures and the housing results will cut inventory and eventually support prices. Consumers are hunkering down and beginning to reduce debt and save more, but the previous quarter could still represent the worst part of the economic contraction. Their retrenchment will certainly prolong the recession, and businesses have reacted by reducing inventory and cutting investment, but what we must look for as investors is the point at which the tide shifts—the undertow might keep pulling, but it does so at a reduced rate.

Now that President Obama has assumed the Oval Office, he is fast at work coordinating a fiscal stimulus package that will go a long way to limit the downside risk of prolonged recession. The proposed package of approximately $800 billion, or roughly 5.5 percent of annualized GDP, would be the biggest since the Great Depression. What remains unclear is whether the tax stimulus will boost after-tax real income all at once or be phased in over two years. Either way the fiscal stimulus is another quiver in the fight against deeper economic and financial malaise.

Fidelity Investments has informed us that they applied and received approval for an IRS extension for 2008 Tax Forms. Their new deadline for providing tax information is March 2, 2009.

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By Bill Schmick, Portfolio Strategist, Dion Money Management

When the U.S. government created tax-deferred 401(k) retirement accounts back in 1972 they never dreamed that together with Individual Retirement Accounts, they would become the primary savings vehicle for more than 50 million Americans. Nor did anyone care as long as these tax-deferred retirement assets continued to grow, but now that over $2.5 trillion of their value have been wiped out in less than a year, well, things are different.

These 401(k) plans were originally intended to be a supplement to the main engine of retirement savings, the company pension plan. Back then most companies offered a defined benefit plan which guaranteed employees a certain income once they retired. The company assumed the risk of the investments so assets were invested conservatively. The system worked well and together with Social Security payments, most Americans believed they would be on Easy Street once they hit 65. To most investors, the 401(k) legislation was simply icing on the cake. It added a bit more to the worker’s nest egg but for the most part it was used by highly-paid company executives to shelter some of their income through tax–deference.

However, companies soon realized that 401(k) s were cheaper to manage and (even better) transferred the investment risk from the company to the employees. A wholesale exodus occurred as pension plans were transferred to these voluntary savings accounts. Companies provided a sweetener by volunteering to “match” a portion of each employee’s contributions when they could. Because all of this occurred during the onset of a multi-year bull market, the increased investment returns appeared to be a win-win for everyone. Who needed stodgy old pension funds when the real action was in technology, energy or emerging markets?

The voluntary nature of the plans is also a problem. The onus was on the individual to save, unlike pension plans where companies contributed a certain amount of money yearly toward the worker’s retirement. Although the government provides an incentive in the form of tax savings for the plans, over time fewer and fewer Americans have contributed less and less to their retirement plans.

Another impediment is the array of investment choices that employees have to consider. I have many clients who are successful professionals in their fields, but that does not qualify them to select from a menu of twenty or more mutual funds in different asset classes. Many times they simply selected the most aggressive choices available reasoning that the markets would continue to go higher. Obviously, that proved to be the wrong strategy in 2008.

Of course, many companies attempt to provide literature or even investment classes for their employees. But crash courses only go so far and how much time does the average employee have to follow the markets and make adjustments to their plans in a timely fashion? Last year even the most experienced market pros couldn’t make the right investments.

Remember too that my generation will use any excuse to avoid saving, and now they have plenty. The decline in the stock markets has devastated their retirement savings. At the same time many companies in a cost-cutting effort have announced they will no longer provide matching contributions to their 401(k) plans. Finally, many workers have stopped contributing feeling they should keep some cash on hand just in case they too join the ranks of the unemployed.

The bottom line: Americans are contributing even less to their 401(k) and IRA plans while their existing savings are inadequate for retirement. Because Social Security payments alone are insufficient to support most American retirees, who or what will be called on to make up the difference? I suspect that today’s baby boomers will look to the government as a back stop and they have the voting power to force the issue.

So expect some changes in the way Americans are encouraged to save. Congress is already conducting hearings on the subject. There may also be adjustments, possibly restrictions, on how our retirement savings can be invested, similar to the guidelines followed by many of our corporate pension funds today. I believe the last thing the government needs right now is to pick up the tab for my retirement, and hopefully the new administration agrees.

Bill Schmick is a Vice President and Portfolio Strategist for Dion Money Management, which offers managed account services for your IRA, Roth IRA, 401(k) and other retirement accounts. He can be reached at 800-432-7447, ext. 146 to learn about the benefits of our managed account programs.

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It has been a long time since one could argue the market got ahead of itself, but by early January the S&P 500 Index had already rallied 27 percent from its intra-day low set during the dark days of late November. One could argue it was an impressive feat given the near endless deluge of bad news and dire headlines paraded before us by the media. Although we cannot expect a V-shaped recovery amidst the economic and financial turmoil surrounding us today, moves such as these are necessary before the stock market can heal itself.

After watching the S&P 500 Index fall more than 10 percent from January 6 through midday trading yesterday, the Federal government stepped into the markets once again, this time shoring up Bank of America. The company, perhaps acting on government wishes, had offered to take over Merrill Lynch in September, the same day that Lehman Brothers filed for bankruptcy protection. Now the government has to pay-up in order for the deal to move forward, as the losses at Merrill threaten to drag down Bank of America, which had also purchased Countrywide at the start of 2008. Treasury will inject $20 billion into the bank, and the Federal Reserve will pick up 90 percent of any future losses on $118 billion in assets.

Federal action may have slowed the market’s descent, but it is very likely that January 6 marked the end of the latest rally that began on November 20. Bear markets do not end until the lows have been tested, and we may see the first test soon, with shares only 10 percent above their lows. Some bearish analysts don’t expect the test to succeed though. Société Général cross asset strategist Albert Edwards thinks the market will break its lows because China will slip into a major depression. He based his estimates on factors such as Chinese electricity consumption and unprecedented drops in exports from Taiwan and Korea, which may signal a decline in intermediate good imports from China.

Nevertheless, I do not expect a return to the gut-wrenching volatility that besieged us last fall, provided the government continues to react with drastic but appropriate measures to provide ongoing stability and liquidity to market participants. These measures are not without their ramifications, but the devil you know is still better than the devil you don’t know. The largely unprecedented intervention provides the best chance we have for economic stabilization in 2009. The speed with which the government reacted last year was even more surprising than the vast market swings that accompanied the Fed and Treasury’s every move, but these efforts should prove appropriate and will keep us from a protracted downturn, and this is why today’s outlook does not resemble that of the 1930s.

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These days, it seems like we can’t turn on the television or open a magazine without seeing an ad for some type of annuity. The options can be bewildering: immediate and deferred; fixed, variable, and equity-indexed. Within these categories are even more options, many available only for a steep price. Some insurance companies have come under fire recently for their aggressive marketing of annuities to consumers who may not fully understand these complicated products.

An immediate annuity is an arrangement with an insurance company whereby you hand over money now—either in the form of a lump sum or a series of payments—in exchange for a more or less guaranteed stream of income that begins immediately. Purchasers of a deferred annuity begin receiving payments at a predetermined date in the future. Regardless of the type of annuity you buy, your investment grows tax deferred. Depending on the source of the money used to purchase an annuity product, however, your income payments can be partially tax-free or taxed as ordinary income.

Many investors think annuities are a bad deal. The most common complaint is high costs. The average annuity carries a 1.40 percent charge, and when you add account maintenance fees to the sales commissions and the expense ratios on a variable annuity’s underlying mutual funds, the overall expense ratio can soar over 3 percent. Another legitimate gripe is liquidity: It can be expensive to retrieve your principal once you have signed an annuity agreement.

There are three basic types of annuities on the market today. The traditional product is the fixed annuity, which provides a guaranteed stream of fixed-dollar payments to the annuity holder. Purchasers of fixed annuities are trading growth for security. A note of caution: Inflation will slowly erode the buying power of the guaranteed payments. Consumers should always beware of the term “guaranteed.” In the case of annuities, the guaranteed income is subject to the credit risk of the insurance company and its ability to pay out its liabilities. Today more than ever, with large financial institutions failing or under great strain, it is worth taking an extra-long look at your provider. Choosing an independent company such as Fidelity Investments may make the most sense.

A variable annuity allows the purchaser to address the problem of inflation by investing the money in a range of stocks, bonds and money market accounts. Equity index annuities are relatively new products that, as their name suggests, tie the account value to the performance of a stock index. The account value from both variable annuities and equity index annuities can rise and fall with the broader securities markets; many companies address the problem of downside risk in these nontraditional annuity products by guaranteeing a minimum return.

Annuities make sense for many investors, particularly retirees, who want to remove some risk from their portfolios. Annuities also make sense for investors who have maximized contributions to their 401(k)s and IRAs and want to make further tax-deferred investments. Due to the severe penalties typically associated with withdrawing principal, you should probably not purchase an annuity unless you plan to keep it for at least 15 years.

As with all investments, be sure you thoroughly understand the terms of your agreement before you hand over any of your hard-earned money. If you know and trust an insurance expert, it’s best to consult him or her; insurance companies have not signed on to “simple English” regarding their policies and agreements.

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Congress created Roth IRAs as part of the Taxpayer Relief Act of 1997. Envisioned as a means of encouraging lower-income taxpayers to put away money for retirement, Roth IRAs have become a popular savings vehicle for investors who meet the tax code’s eligibility requirements. At the end of 2007, Roth IRAs held an estimated $178 billion in retirement savings.

There are two ways to set up a Roth IRA, either through regular contributions—much as you might contribute to your company’s 401(k) plan—or through a conversion of assets held in a traditional IRA. Under current law, only traditional IRA assets may be converted to a Roth IRA, although the Pension Protection Act of 2006 made it possible for direct conversions of 401(k) assets into Roth IRAs, beginning in 2008.

Why would someone want to do a Roth IRA conversion? It’s all about taxes. The Roth IRA is funded with after-tax dollars, but withdrawals in retirement are tax-free. Traditional IRAs, by contrast, are typically funded with pre-tax dollars, but account holders must pay ordinary income tax on withdrawals. The conventional wisdom ever since the Roth IRA came into being was that it made sense to do a conversion if you anticipated retiring in a higher tax bracket. The rationale was that it’s better to pay lower taxes on your money now than higher taxes on it later.

Only certain taxpayers can do the conversion. Married taxpayers filing separately are not eligible, and everyone else must meet what the IRS calls a “modified AGI requirement.” Only taxpayers—both those filing singly and married couple filing jointly—whose modified adjusted gross income for the conversion year is $100,000 or less can convert their traditional IRA assets. Beginning in 2010, Americans who earn greater than $100,000 will also qualify for the conversion.

The IRS gives you three ways to accomplish the Roth IRA conversion:
1.    Trustee-to-trustee transfer, or rollover.
2.    Redesignation as a Roth IRA by the same trustee.
3.    Payment of the distribution from the traditional IRA into a Roth IRA within 60 days of distribution from a traditional IRA.

The amount of your Roth IRA conversion is not subject to the 10 percent penalty the IRS imposes on early withdrawals from IRAs, although the conversion amount will be taxed as ordinary income during the conversion year. Note that nondeductible IRAs may also be converted to Roth IRAs. In this case, ordinary income tax is paid on the difference between the account value on the date of conversion and the total amount of the nondeductible contributions. In order to avoid having the IRS impose the early withdrawal penalty, assuming you’re under 59½, you must follow the IRS’s guidelines for doing the conversion.

Now back to that conventional wisdom. If you’re eligible, a Roth IRA conversion is a powerful and flexible way of managing your retirement assets. After your conversion account has been open for at least five years, for instance, you may withdraw your contributions (but not earnings) for any reason without paying taxes or penalties, regardless of your age. Because the IRS has already taken its cut, there are no minimum required distributions from Roth IRAs, so you may pass your account along to your heirs intact, if you wish.

It may very well make sense to do a conversion, but your future tax bracket may be just one part of the analysis. One important factor to consider is the investment opportunity costs of taking money out of a tax-deferred growth account to pay a voluntarily-assumed income tax liability. Another risk is a change in the tax laws that could make Roth IRAs less attractive. A final note: if you have to keep part of the distribution to pay the taxes on your Roth IRA conversion, then it’s probably not worth it. Remember the IRS will impose a 10 percent penalty on early withdrawals from your traditional IRA.

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