Second Quarter 2006 Review
"April is the cruelest month, breeding lilacs out of the dead land, mixing memory and desire, stirring dull roots with spring rain." T.S. Eliot
Perhaps April wasn't so bad after all. May, however, was difficult. The U.S. stock market, as measured by the Standard and Poor 500 Index and the Russell 2000, meandered from its starting point on April 3rd to the end of the quarter on Friday, June 30th, closing almost where it began. The S & P 500 began at 1297 and ended the quarter at 1270. The Russell 2000, an index of smaller companies, began the quarter at 759 and ended at 724. The second quarter was a time of worry for investors: higher prices at the gas pump, higher interest rates, war in the Middle East, plus a dose of any and all the bad news that the news media could report.
As I so often do, I again remind my clients that the news is a product we all buy. When we read a newspaper, listen to radio news or TV news reports, we are buying a product called the BAD NEWS. Good news doesn't sell. There is plenty of good news to report. The stock market goes up in anticipation of good news of better days ahead. Volumes of good news go un-reported. The good news that is reported is often buried in the middle or end of the newspaper or broadcast. A barrage of bad news can affect us negatively. As the great humorist and social commentator, Will Rogers so often said, "I only know what I read in the papers." If everything we read in the papers and hear on radio or on TV is negative, no wonder so many of us think negatively. Dr Wayne Dyer, the well known philosopher and teacher said it so well: "We become what we think about all day long." Dwell on the negative and you can easily fall into negative thinking. At least balance the bad news with a dose of good news and a little hope for the future. Investing is about hope for the future. One hundred years ago some people believed that most of the things that could be invented had already been invented.
There has never been a time when the future was clear. There has never been a time of absolute certainty. Investing is the act of purchasing assets that are expected to perform positively over time, regardless of turmoil and tempests. In this letter I will review certain economic environments and some of the approaches to investing that should likely produce needed money for future delivery. Please pass this letter and our brochure on to your younger friends and family members who may be among the millions who have not yet accumulated funds for the future. Call me if you would like additional copies.
Concerns about the economy and a distrust of investing in assets that can change in value keep millions of us from buying stocks, mutual funds or investment real estate. Of course, there is no perfect investment, one that grows aggressively in value, pays very high dividends or interest, is guaranteed not go down in value and isn't fattening. If such an investment existed, we would all own it and we'd all be rich and thin. Investors who want to avoid the price volatility of stocks and real estate require the guarantee of insured savings accounts. Investing exclusively in bank accounts and CDs holds the risk of losing purchasing power during retirement. Unless a saver can accumulate enough cash to generate the needed income, he or she could run out of money. As a hypothetical example, if a bank CD yielded exactly 5% for the rest of a retiree's life, and if our retiree required an additional $30,000 per year to supplement Social Security and other income, the lump sum necessary to generate this income without withdrawing any principal must be at least equal to $600,000. There would be no increase in income to keep up with the cost of living because the CD would generate exactly $30,000 per year, no more, no less.
An alternate choice for our retiree might be an immediate annuity purchased from a life insurance company. An annuity contract is the only investment vehicle that can guarantee to pay an individual an income that cannot be outlived. (Winners of state lotteries are paid out over time via annuity-type payment plans). Annuities are tax deferred during the accumulation phase prior to taking income. The "annuitized" contract's income is partially tax-free because part of the payment is treated as a return of principal. Many annuities can accept periodic payments. Withdrawals prior to age 59 ½ may be subject to a Federal tax penalty of ten per cent of the amount withdrawn. Annuities can also be purchased in laddered form. Using two, three or more annuity contracts, retirees or those requiring structured settlements might set up the first contract to pay out principal and interest for, say, five years. Then, at the conclusion of the first contract the income stops and the second annuity contract, which has been earning interest tax-deferred for five years, can be "opened up" to pay monthly income for another sixty months. The third follows suit, and so on. If the annuitant (the person receiving the income) is young, the final (fourth or fifth) annuity contract might begin paying a guaranteed life income, instead of another five-year income stream. These annuity strategies can be custom designed for each individual. Life annuities, those that guarantee to pay as long as the annuitant is alive, pay more per month the older the annuitant is at the time the income begins.
However you decide to save, begin as early as possible. I recommend that every person and family create a written budget that includes putting away at least 10 % of current income. It is possible to live on 90 %. Once income increases beyond the necessities, some families try to set, as an annual gifting goal, a certain percentage of income. This is, of course, not practical for many families, especially young families with growing children. A good effort made toward the goal of saving and investing as much as possible can make a huge difference given enough time.
For those who are NOT averse to choosing the stock market, the choices are vast. Some investors prefer individual stocks. There are advantages to selecting individual securities. Among them is the ability to set "stop-loss" orders under specific stocks. The stop-loss order becomes a market order to sell the stock should it drop below some predetermined level. The stop-loss order can be raised if the underlying stock increases in value. Also, in a flat market, where stock prices muddle along and seem to trade up and down along a horizontal price axis, selecting high dividend-paying stocks offers income during the directionless time. Using a combination of stop loss orders with dividend payers might be one of the better ways to hunker down and get paid until the market resumes its historic long-term upward capital growth trend, assuming, of course, that free-market capitalism, the mother's milk of capital growth, is not hindered by our electing a communist government in America, or the occurrence of some other unimaginable calamity.
Other investors may want the professional full-time management of a portfolio run by an investment company, commonly called a mutual fund. According to the Investment Company Institute, as of June, 2006, investors held $ 9.3 trillion in over 15,000 different mutual funds representing investment styles of many stripes. There are U.S. domestic funds with stocks, bonds and combinations of stocks and bonds; global funds; and funds that buy small, mid-sized and large company stocks. There are funds that buy tax-free municipal bonds; some buy only Government bonds. Other funds buy real estate investments. The variety can seem bewildering. I generally look for those investment companies that enjoy great reputations and have been around for a long time. As with any investment, the choices must be suitable for the individual.
Every mutual fund is offered to a prospective investor by prospectus. Only properly licensed "registered representatives" can sell mutual funds. Each new investor should understand the investment and the suitability issues. Be sure to ask questions! There is no need to listen to a fire sale presentation. There are always enough shares available. You don't have to buy today. Take your time, consider your needs and goals and learn about the investment choices that are recommended to you.
I am interested in developing very long term investor/advisor relationships with our clients. These relationships must be earned. Many of us who are Certified Financial Planner Practitioners are trying to convert the business of securities and insurance sales into the profession of client advocacy. One definition of a professional relationship is one in which a client's interests are put ahead of the advisor's interests.
I'm concerned that many younger Americans are not putting away enough money for the future. The single best long-term saving vehicle is, in my opinion, the Individual Retirement Account. IRAs are available to individuals under the age of 70 ½ who are employed. Non-working spouses are entitled to contribute to their own "Spousal IRA". Owners of small businesses might consider "Safe Harbor" 401(k) plans. Such plans benefit both owners and employees. Call me for more information.
Rabbi Harold Kushner wrote a best selling book called When Bad Things Happen to Good People. Bad things can and do happen every day. Sometimes there is no way to avoid unfortunate events. The insurance industry exists because people need a way to repair damage to a dented car or blocked cardiac artery.
Life insurance contracts have existed for over three hundred years. There is no better financial tool than life insurance to replace some lost income due to the death of a bread winner. Life insurance in an irrevocable life insurance trust can pay estate taxes with income tax-free and estate tax-free proceeds at the death of the owner of valuable illiquid property.
Health insurance helps pay for medical care. Disability insurance pays you when you're hurt or ill and can't work. Long term care insurance helps pay for expenses associated with nursing home or at home acute or chronic care.
If you are a home owner, be sure to regularly review your property and casualty coverage. If you own a car, be sure your coverage is more than adequate. Lawyers can advertise now. For years, it was not allowed. Now we're told that attorney so and so will work hard to get you the money you deserve. Be sure the money he's going after isn't yours. I have heard the term "insurance poor" for the thirty one years I've been in financial services. Insurance poor might be better than just plain poor due to an un-insured loss.
There are many reasons for not saving and investing. Some of the reasons are good. Sir John Templeton said, among his other pithy comments, "The best time to invest is when you have the money." Not when conditions are just right, because they never will be. There will wind, hail, fire and drought. In the meantime, invest when you have the money. Pay off your debts as soon as you can. Maintain very good credit. Good credit is the password to getting your first home mortgage. Banks loan money to people who don't desperately need the money. They loan to good credit risks. Banks are businesses, not charities.
If you need help getting started with your financial planning, call a Certified Financial Planner Practitioner or other qualified advisor. Avoid making excuses. There's no money in them. You don't need a new design for the financial wheel. It's already been invented. Be independent as soon as possible in life. Lottery tickets are taxes paid by willing taxpayers. Very few win.
Create a written plan, including a monthly and annual budget. Follow it. Learn about compound interest. Albert Einstein thought that compound interest was one of mankind's best discoveries. If you are young, you have a huge advantage over those of us who are no longer young. Time is on your side. Build your financial future using the building blocks of regular savings, adequate insurance, good planning, asset diversification, knowledge and time.
Wishing you success,
Robert W. Brimmer, CFP™