The More Things Change....

Considering the American debt ceiling fiasco, all the political turmoil, a European debt crises, and unemployment at 9 percent, there are plenty of reasons to be concerned about the stock market and the state of the global economy. Consequently, markets have moved downwards since April as all these factors have been digested by investors. Investments within all asset categories have experienced increased and alarming volatility over this period. Naturally, investors and those close to retirement are concerned.

I decided to look at my previous articles to find a way to reflect on recent events; I didn’t have to look for long. Here is an excerpt from the first newsletter I published back in March of 2009:

How volatile is this investment environment? As measured by the S&P 500, the market moved more than 3% in either direction during a single day only once between 2004 and 2007. By comparison, the market moved at least 3% in one day 40 times in 2008. Further, moves of 2% to 3% occurred 28 times during the calendar year.

For those who see no end in sight for this volatile market, remember -- we have been here before! Between 2001 and 2003, the market moved between 2% and 3% an average of 20 times per year, and that was over a three year period! We then moved on to enjoy a relatively stable and profitable period between 2004 and 2007. Thus, history indicates that the increased volatility we are currently seeing in the market is not the "new norm" and we should expect volatility to subside at some point, creating a more reasonable investment environment for all.

I researched the performance of the S&P 500 during 2011 and found that the market had moved 3% or more in either direction only 9 times this year, and 4 of those times the moves were positive. Additionally, moves of 2% to 3% have occurred only 14 times during the calendar year. Again, I can look back and say “we’ve been here before” and point to another example of moving on to more calm and profitable times -- 2009 and 2010. In addition, by comparison, the volatility we’ve recently experienced is actually quite tame compared to market fluctuations we’ve experienced even recently.

The human mind has a unique way of interpreting events relating to investing hard-earned money. We always convince ourselves that current times are unlike anything that’s been experienced before and that today’s problems are more difficult and numerous than yesterday’s problems. The present never seems like a good time to invest and save – we always want things to settle down and be more stable before investing. Unfortunately, these are the feelings that are present in the marketplace 75% of the time. Even worse, if you wait for the 25% of the time when investors feel comfortable you have likely already missed the boat and are likely to have invested immediately after the market has experienced a profitable run.

This is the reason having a well thought out and devised investment strategy teamed with a long term approach is so critical to investment success. The mind of an investor will never make things easy. There will always be a reason for heightened fear or concern, a reason to sell or not invest. Fortunately, investment advisors can add tremendous value in overcoming these obstacles. Do you have an investment strategy? Can you write on a piece of paper exactly the logic used to determine why you hold the investments you currently own? Have you documented which elements of your portfolio are designated to provide income during various periods of your life? Have you established safe measures that will prevent you from selling in the middle of a panic and ensure you don’t end up buying high and selling low? A financial planner can help you answer these questions.

Too often we wait until the market has had an impressive run to feel confident putting our money to work. This is why having a sound investment plan can help you avoid making investment decisions with only a short-term focus. It is also why having a financial planner on your side to ensure you stick to a well-defined strategy during both good and bad times will ultimately maximize your chance of achieving your investment goals.

Is A Roth Recharacterization Right For You?

In 2010, many people took advantage of law changes enabling them to convert their traditional retirement accounts to a Roth IRA. The intention was to pay taxes on those retirement dollars in 2010 and enjoy tax-free growth going forward.

While this is likely still a sound strategy, the recent market downturn may provide a less expensive opportunity to do this. Consider the example of an individual in the 25% Federal tax bracket who converted $100,000 of retirement funds to a Roth IRA in 2010. In doing so, this investor paid $25,000 in taxes so that all future earnings in the Roth account would grow tax-free.

Now suppose this investor’s current account value has dropped to $80,000 during the volatile market we’ve experienced. An investor might argue that it was unfair to pay taxes on $100,000 of income when the asset is now only worth $80,000. Believe it or not, the IRS is willing to agree.

By recharacterizing the 2010 Roth conversion, both the investor and the IRS can pretend that the 2010 Roth conversion never took place. Essentially, the investor is converting the Roth dollars back into a traditional IRA account where taxes are again deferred and it’s like the Roth conversion never happened. This eliminates the tax bill that was created by the original Roth conversion.

As most people have already filed their 2010 tax returns, they will need to file an amended 2010 return in order to eliminate the reference to the Roth conversion and receive a refund of any unnecessary taxes paid.

What if the investor still prefers the tax-free treatment a Roth IRA provides? Amazingly, the IRS provides an opportunity to still take advantage of these great investment vehicles. After 30 days have passed since the individual recharacterizes his Roth account back to a Traditional IRA account, the investor can against convert the funds back to Roth dollars. What is the advantage of this? Now the investor is paying taxes on $80,000 of income rather than $100,000. Assuming the taxpayer is still in the 25% Federal bracket, the tax bill would now be $20,000. Thus, by recharacterizing and re-converting, the individual lowered their tax bill by $5,000!

The small hassle of this process may not be worth it if the tax savings will only be a couple hundred dollars. However, if you’re due to lower your cost by thousands of dollars, it is definitely something you should look into.

If you converted retirement funds to a Roth IRA last year, speak to your financial advisor to determine if you might be able to reclaim any unnecessary taxes you have paid. Notice: applications for Roth recharacterizations are due October 17th.