Is Traditional Buy and Hold Investing Dead?

 

The last 18 months in the financial markets have been described as a once-in-a-lifetime event.  With financial and credit markets in turmoil, it seems that most investment portfolios, from individual 401(k)’s to large endowments suffered staggering losses.  The result is that many advisors are now rethinking their investment philosophy.

Most mainstream investment theory has traditionally fallen into two distinct camps.   Those that advocate a buy-and-hold strategy with periodic rebalancing of a diversified portfolio and those that espouse active trading based on short-term technical indicators. 

Traditional Buy and Hold

Those that adopt this philosophy feel that over the long term, nobody can accurately predict the short-term movements of the markets and therefore cannot outperform the overall market.  They argue that in order to maximize long-term results and reduce volatility, the best approach is to build a portfolio made up of numerous asset classes like stocks, bonds, real estate and private equity.  The thought is that the different asset classes are not closely correlated, meaning that they don’t all go up or down at the same time.  While one asset class (i.e. large cap stocks) may be dropping, another portion of the portfolio (bonds or commodities) should be rising.  By periodically rebalancing back to the original allocation, as different asset classes over or under perform in the short term the overall volatility of the portfolio should be reduced and returns increased.

This latest bear market however, has seriously put to doubt the basic tenets of the buy-and-hold strategy.  In 2008, while we saw some asset classes rise quickly for a short time (oil and commodities) eventually almost every asset class, except Treasury bonds and cash, showed negative results, decimating even the most diversified portfolios.  Markets like the one we’ve seen recently add credence to those that favor active trading.

Active Trading

Active traders feel that by analyzing price patterns, they can capitalize on short term inefficiencies and broader movements in the financial markets, both up and down, to maximize returns over the long run.  These traders are not concerned with which asset class they are trading, or whether that asset is trending up or down.  Their approach is to get in and out of markets quickly, taking small profits as they go.

2008 was a potentially great year for active traders since there were large movements in numerous asset classes like stocks, bonds and commodities.  By being able to profit from both up and down markets, some active traders were incredibly successful.

A Hybrid Model

After the last bear market, many advisors, including our firm, moved to a hybrid model, calling it things like ‘Buy & Hold with a Tactical Overlay’ (quite a mouthful) or ‘Core and Explore’.  No matter what they call it, these advisors are using the same methodology.  In this approach, they build the core portfolio across numerous asset classes just like the traditional buy-and-hold philosophy, periodically re-balancing to maintain the original asset allocation.  For the balance of the portfolio they will use a limited form of active trading, taking advantage of shorter-term trends in the market to over or under-weight certain asset classes based on their judgment of their relative value.  This allows them to reap the benefits of long-term investing while taking advantage of very real, short-term circumstances.

Which Approach is Right for You?

Like any long race, there are many ways to reach your destination and as a result, there is likely no single right approach to investing.  The important thing to remember is that it’s the end result that’s important, not how you got there.  Your choice of advisor and approach should come down how well the advisor articulates their particular philosophy to what you’re comfortable with that approach.  The best thing you can do is to ask your advisor what their investment philosophy is and whether or not it suits your personality.  The most important thing is that you understand how they do things and that you have a plan in place that you can stick to, even in challenging markets.

Next Steps

If you’d like to learn more about how RTJ Financial Management builds its portfolios and the investment approach we take, simply drop us an email at info@rtjfinancial.com with ‘Portfolio Review’ in the subject line, and we’ll schedule a free, no-obligation one hour portfolio review with you.

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Is Now The Time to Convert Your Traditional IRA to a Roth IRA?

 

With great adversity comes great opportunity. While nobody likes to see the account balances in their IRA drop 40% or more, the reduced value in your IRA may make it an opportune time to convert your Traditional IRA to a Roth IRA since it will cost you much less in taxes than it would have in any of the past 4 years.

Traditional IRA vs. Roth IRA Basics

A Traditional IRA allows you, with some limitations, to deduct your IRA contribution when you make it. Over time, your account grows tax-free until you start taking distributions. Once you begin to take distributions, the amount you take each year after age 59 ½ is taxed at your rate at your current income tax rate.

A Roth IRA on the other hand, does not provide you with an up-front tax deduction. Like the Traditional IRA, your account grows tax-free but, unlike a Traditional IRA, when you take distributions there is NO tax liability.

Why Convert?

Roth IRA’s have four big advantages:

1. Tax-free growth. Like a Traditional IRA, the growth in your account is not taxes.
2. Tax-free withdrawals. As long as you’ve owned your Roth IRA for five years or have reached age 59 ½, the amount you take out of the account is not taxed.
3. Contributions can be made after age 70 ½. While you can longer make contributions after age 70 ½ in your Traditional IRA, there is no such restriction for the Roth IRA.
4. No mandatory distributions. In a Traditional IRA, one you reach age 70 ½, you must start taking Required Minimum Distributions (RMD’s) each year from the account. Because you didn’t get an up-front tax deduction for your Roth IRA, you’re not required to take RMD’s.

Reasons Not To Convert

1. Taxes. When you convert from a Traditional to a Roth IRA, you’ll need cash to pay taxes on the earnings and pre-tax contributions you made. Warning: you can’t use your IRA to pay the taxes since the amount you use for taxes would be considered an early withdrawal, subject to income tax and a penalty.
2. You anticipate being in a lower tax bracket in the future. If you’re currently in the 35% tax bracket and you think you’ll be in the 25% bracket in retirement, you’ll be paying taxes at your higher current rate.

Who Is Eligible to Convert?

In 2009, in order to be eligible to convert your IRA, you must have an Adjusted Gross Income (AGI) of less than $100,000. In 2010, there will be no income limitation on a Roth conversion.

Do-Over

If the market continues to tank through 2010, the government has provided you with the ability to take a mulligan. Otherwise known as a ‘re-characterization’, this give you until October 15, 2010 to reverse your decision to do the conversion in 2009 and re-do it on the new lower amount in your IRA.

Consult a Professional

The tax code is a fluid, complex animal. Before undertaking this type of conversion, be sure to consult your CPA or tax professional to ensure that you do everything right to avoid an unnecessary complications.

How Barack Obama’s Economic Policies Might Affect You

Congratulations to Barack Obama on becoming our 44th President.  It’s truly an historic moment when an African American man can ascend to the highest office in the land and it shows how far this nation has come in the last 40 years when it comes to racism.  Whether you voted for him or not, you have to admit that it is once again going to be an interesting time in America.

Mr. Obama comes into the office with an economy clearly on the decline and financial markets still largely in turmoil and he admitted that it will be an uphill climb for his administration to fix these issues.  How that will be done remains to be seen, but we can glean some insight into his economic philosophy from his comments at the debates to the numerous press interviews he’s granted over the course of the campaign.  Here are some of the trends you can anticipate during the Obama Presidency.

Capital Gains Taxes

Throughout the campaign, Mr. Obama has said that he would like to increase the tax rate on long-term capital gains.  Currently the rate sits at 15% and Mr. Obama has said he might raise them as high as 28%, which was the rate when Bill Clinton took office.

What should you do?  If you’re convinced he will raise the capital gains rate next year, you should realize as many gains in this year as possible so you can benefit from the low current rate.

Income Taxes

Mr. Obama has said that he intends to reduce income taxes on those making less than $250,000 per year and raise taxes on those making more than $250,000 per year.

If you’re currently make less than $250,000 per year and you anticipate you will make less than that in 2009, then pushing income into next year should save on your taxes.  If you make more than $250,000 then you should push as much income into this year in anticipation that your taxes will go up under the Obama plan.

Infrastructure Upgrades

We all know that our roads and bridges are, in many places, in dire need of repair or replacement.  During the campaign, Mr. Obama indicated that one of the tools he might use to prop up the economy is to use Federal money to do those repairs, thus pumping billions of dollars to construction companies, heavy equipment manufacturers and construction-related jobs.

If Mr. Obama is successful, you should position a portion of your portfolio to take advantage of those industries that would benefit, like construction and equipment makers.

Barack Obama has certainly sparked the imagination of many Americans and it’s good to see a sense of enthusiasm out there again.  The few items we’ve listed is far from an exhaustive list and I’m sure that, as we transition from the Bush Presidency to the Obama Presidency, many other trends will begin to develop.  All we can do is to try to stay on top of those trends so that we can all benefit to the greatest degree possible as this country recovers from our current economic malaise.

America rocks!!

San Diego Aims To Be The First Stupidity and Greed Sanctuary

Reuters news agency today reported that San Diego City Attorney Michael Aguirre had filed suit against Bank of America and it’s Countrywide subsidiary to prevent the mortgage lenders from foreclosing on homes in his city.  He also plans to file similar suits against Washington Mutual, Wachovia and Wells Fargo in the near future.  The state goal is to make San Diego a “foreclosure sanctuary.”

More aptly, Mr. Aguirre should have said that he wants to make San Diego the first “Stupidty and Greed” sanctuary.

For those that aren’t aware San Diego was one of the first markets to experience the run-up in real estate prices and also had some of the highest appreciation rates in the country.  San Diego was also known for the zeal with which it’s residents speculated on the real estate market.  With the credit crisis, San Diego has now lead the market with some of the steepest losses in the country.

As with any speculative bubble, this one was characterized by people taking out aggressive loans, that they probably couldn’t afford, believing that the market would continue to climb at its torrid pace, ultimately allowing them to refinance, take out cash and generally live the good life.  In other words, stupidity and greed took over until the market corrected and those same people were stuck with potentially huge losses.

By suing lenders to prevent them from foreclosing, San Diego has essentially condoned this stupid and greedy behavior and given it its stamp of approval.  While undoubtedly well-intentioned, these lawsuits are encouraging the wrong behavior.  Instead of encouraging people to be accountable for their actions and live within their means, the city of San Diego has essentially told its citizens “It’s OK to take unnecessary financial gambles.  If it doesn’t work out, we’ll bail you out.”

So, if you’re planning on doing something greedy and stupid, move to San Diego so you can find “sanctuary” from your actions.