May 2008 Newsletter

Waddell & Reed Geoffrey S. Morse Financial Advisor 4218 S Steele Street Suite 215 Tacoma WA 98409 (253) 474-9555 gsmorse@wradvisors.com

To find out more click here. Monitoring Your Portfolio You probably already know you need to monitor your investment portfolio and update it periodically. Even if you’ve chosen an asset allocation, market forces may quickly begin to tweak it. For example, if stock prices go up, you may eventually find yourself with a greater percentage of stocks in your portfolio than you want. If stock prices go down, you might worry that you won’t be able to reach your financial goals. The same is true for bonds and other investments. Do you have a strategy for dealing with those changes? You’ll probably want to take a look at your individual investments, but you’ll also want to think about your asset allocation. Just like your initial investing strategy, your game plan for fine-tuning your portfolio periodically should reflect your investing personality. The simplest choice is to set it and forget it–to make no changes and let whatever happens happen. If you’ve allocated wisely and chosen good investments, you could simply sit back and do nothing. But even if you’re happy with your overall returns and tell yourself, “if it’s not broken, don’t fix it,” remember that your circumstances will change over time. Those changes may affect how well your investments match your goals, especially if they’re unexpected. At a minimum, you should periodically review the reasons for your initial choices to make sure they’re still valid. Even things out To bring your asset allocation back to the original percentages you set for each type of investment, you’ll need to do something that may feel counterintuitive: sell some of what’s working well and use that money to buy investments in other sectors that now represent less of your portfolio. Typically, you’d buy enough to bring your percentages back into alignment. This keeps what’s called a “constant weighting” of the relative types of investments. Let’s look at a hypothetical illustration. If stocks have risen, a portfolio that originally included only 50% in stocks might now have 70% in equities. Rebalancing would involve selling some of the stock and using the proceeds to buy enough of other asset classes to bring the percentage of stock in the portfolio back to 50. This doesn’t represent actual returns; it merely demonstrates how rebalancing works. Maintaining those relative percentages not only reminds you to take profits when a given asset class is doing well, but it also keeps your portfolio in line with your original risk tolerance. When should you do this? One common rule of thumb is to rebalance your portfolio whenever one type of investment gets more than a certain percentage out of line–say, 5 to 10%. You could also set a regular date. For example, many people prefer tax time or the end of the year. To stick to this strategy, you’ll need to be comfortable with the fact that investing is cyclical and all investments generally go up and down in value from time to time. Forecast the future You could adjust your mix of investments to focus on what you think will do well in the future, or to cut back on what isn’t working. Unless you have an infallible crystal ball, it’s a trickier strategy than constant weighting. Even if you know when to cut back on or get out of one type of investment, are you sure you’ll know when to go back in? Mix it up You could also attempt some combination of strategies. For example, you could maintain your current asset allocation strategy with part of your portfolio. With another portion, you could try to take advantage of short-term opportunities, or test specific areas that you and your financial professional think might benefit from a more active investing approach. By monitoring your portfolio, you can always return to your original allocation. Another possibility is to set a bottom line for your portfolio: a minimum dollar amount below which it cannot fall. If you want to explore actively managed or aggressive investments, you can do so–as long as your overall portfolio stays above your bottom line. If the portfolio’s value begins to drop toward that figure, you would switch to very conservative investments that protect that baseline amount. If you want to try unfamiliar asset classes and you’ve got a financial cushion, this strategy allows allocation shifts while helping to protect your core portfolio. Points to consider Keep an eye on how different types of assets react to market conditions. Part of fine-tuning your game plan might involve putting part of your money into investments that behave very differently from the ones you have now. Diversification can have two benefits. Owning investments that go up when others go down might help to either lower the overall risk of your portfolio or improve your chances of achieving your target rate of return. Asset allocation and diversification don’t guarantee a profit or insure against a possible loss, of course. But you owe it to your portfolio to see whether there are specialized investments that might help balance out the ones you have. Be disciplined about sticking to whatever strategy you choose for monitoring your portfolio. If your game plan is to rebalance whenever your investments have been so successful that they alter your asset allocation, make sure you aren’t tempted to simply coast and skip your review altogether. At a minimum, you should double-check with your financial professional if you’re thinking about deviating from your strategy for maintaining your portfolio. After all, you probably had good reasons for your original decision. Check to see that the nature of what you’ve invested in hasn’t changed. For example, you may have a mutual fund that’s investing more overseas now than it was when you originally bought it. That could mean that your overall international exposure is higher now than when you first invested. This kind of “style drift” can affect the risk you’re taking without your knowing it. Some investments don’t fit neatly into a stocks-bonds-cash asset allocation. You’ll probably need help to figure out how hedge funds, real estate, private equity, and commodities might balance the risk and returns of the rest of your portfolio. And new investment products are being introduced all the time; you may need to see if any of them meet your needs better than what you have now. Balance the costs against the benefits of rebalancing Don’t forget that too-frequent rebalancing can have adverse tax consequences for taxable accounts. Since you’ll be paying capital gains taxes if you sell a stock that has appreciated, you’ll want to check on whether you’ve held it for at least one year. If not, you may want to consider whether the benefits of selling immediately will outweigh the higher tax rate you’ll pay on short-term gains. This doesn’t affect accounts such as 401(k)s or IRAs, of course. In taxable accounts, you can avoid or minimize taxes in another way. Instead of selling your portfolio winners, simply invest additional money in asset classes that have been outpaced by others. Doing so can return your portfolio to its original mix. You’ll also want to think about transaction costs; make sure any changes you’re contemplating are cost-effective. No matter what your strategy, work with your financial professional to keep your portfolio on track. The accompanying pages have been developed by an independent third party. Forefield’s content and information is provided for informational and educational purposes only. Neither Forefield Inc. nor Forefield Advisor provides legal, tax, insurance, investment or other advice and should not be relied upon for such purposes. Waddell & Reed does not guarantee their accuracy or completeness, and they should not be relied upon as such. These materials are general in nature and do not address your specific situation. For your specific financial planning and investment needs, please discuss your individual circumstances with your Financial Advisor. The accompanying pages may include information regarding retirement plans, estate planning, business planning or a variety of other topics that involve tax and legal issues beyond the scope of Waddell & Reed’s area of practice and expertise. Such information is intended to explain or illustrate planning topics, options or strategies that you may wish to consider in advance of, or at the time of, seeking the assistance of legal and/or tax advisors in implementing your plans and should not be considered as an authoritative or comprehensive explanation of any of the particular planning topics, options or strategies described. The information in the accompanying pages describes the general aspects of various planning topics, options or strategies but does not necessarily address all the pertinent facts and issues of your personal situation. Waddell & Reed does not provide tax or legal advice, and nothing in the accompanying pages should be construed as specific tax or legal advice or may be relied on for the purpose of avoiding any federal tax penalties. The selection of appropriate planning options or strategies should be made on an individual basis after consultation with appropriate legal, tax and financial advisors. It is important that you retain the services of legal counsel to plan and implement any legal documents that you may require and that you consult a tax advisor for an explanation of the tax effects of any particular planning options or strategies on your personal financial situation. Waddell & Reed financial advisors are able to offer insurance products through arrangements with insurance companies. Guarantees provided by insurance products are subject to the claims-paying-ability of the issuing insurance company.   Copyright © 2008 Forefield Inc. All rights reserved.

 

Economic Stimulus “Rebates”

With checks arriving any day, there is much talk concerning the economic stimulus package.  Many are calling for recipients to spend the money to help the economy keep moving.  Other reports talk of the money being used to pay down debt or used to enhance savings.

While these are all good for individual family situations, they are all the same thing for the general economy.  Whether you spend the money on gasoline, a new gadget or toy, or you invest the money with your broker or in your retirement account, it is still going into the economy.  The only place I think it may be a bad idea to but the money is toword debt.  Unless the debt is high-interest (i.e. double digit) it makes more sense to invest the money for yourself.  Some may ask why.  Quite simply, you are almost always going to have debt.  And debt is not always a bad thing–if you manage it correctly.  Also if you constantly try to pay down your debt, especially the lower interest kind, you will never have a chance to save for yourself.  Let’s look at some numbers.

Imagine you are a married family of four (if this describes you it shouldn’t be too difficult) and you had more than $3000 of income last year and you paid taxes.  This means you will receive a rebate of $1800.  Sure you could buy something–a new computer, TV, gas for the summer trip–but if you saved that money, it could stack up to big money.  And depending on where you invest it, you could actually save on future taxes.  How much would this add up to?  Assuming an annual investment return of 8%, 10 year value is $3,886, 20 year value is $8,390, 30 year value is $18,113.  Pretty significant totals from just a small $1800 investment.  Just think what investing that much every year could do for you!  In case you were wondering, after 30 years it would add up to $238,335!

Would you like to double your pleasure?  Take your rebate money and invest it in a traditional IRA.  You will get a tax deduction for that contribution and the growth will be tax-deferred until you withdraw that money in retirement.  Or invest it in a Roth IRA and that growth will be tax free when you withdraw it in retirement.  Additionally, with the increase in the contribution limits for IRAs/Roth IRAs, it is possible to really develop a nice nest egg.  Don’t hesitate to ask me any questions or get in touch with your local financial advisor.