From the Wall Street Journal: "Charles Farrell, an investment adviser in Denver, has long written about financial planning.  In particular, he has developed, in recent years, some of the smartest tools we've seen for gauging the health of your nest egg.  Now, he has combined these calculators with additional guidelines in a new book...Mr. Farrell uses easy-to-understand ratios to help individuals mange savings, debt, investments and insurance, all with the goal of achieving a secure retirement.  In short, one of the best financial books to cross our desks this year."

 
To learn more about the book and Charlie's research, you can visit his book website at www.yourmoneyratios.com

U.S. Treasury obligations, one of the few sectors in the bond market that actually provided positive returns in 2008, were basically the only sector to provide negative returns in 2009. In fact, 2009 was all about chasing more risk in the search for return.  As it turned out, the more risk you assumed, including credit risk and maturity risk, the higher your return. To wit, long term "high-yield" bonds, otherwise known as junk bonds, had a total return of nearly 60% in 2009. This in spite of the fact that we are just one year removed from a period in which the bond market ceased to function normally for all intents and purposes. What has fostered this "dangerous" behavior? There are a number of factors that have likely played a part in this process.
 
The fact that the fixed income markets actually did continue to function, with an extraordinary amount of monetary and fiscal stimulus from various government entities, was a meaningful contributor to this performance.  There was a return of confidence in our markets and the sense that our economy would weather this very difficult period. The Federal Reserve has continued to pursue a very accommodative monetary policy by keeping short term interest rates at basically zero.  This latter point may have been the catalyst for the significant amount of asset flows out of short term investments into longer term bonds, fixed income mutual funds and exchange traded bond funds. According to Lipper, inflows into fixed income mutual funds during 2009 totaled a record $207 billion.  Astonishingly, 85% of those inflows were into junk bond funds. 2009 will go down as a year, from a bond market perspective, of flight from quality. However, our approach to the construction and management of the fixed income portion of portfolios is quite different and does not involve following the crowds.  

We look to the fixed income portion of portfolios primarily for attractive and predictable cash flows, and to provide a certain amount of stability for the overall portfolio. There are two primary risks involved in bond market investing, credit risk and interest rate risk.  We address the credit risk, or risk of default, by focusing strictly on the highest quality bonds including U.S. Treasury obligations, government agency bonds, and investment grade corporate and municipal bonds. This way we can have a level of confidence in not only the return on principal, but the return of principal at maturity.
 
We mitigate the interest rate risk by sticking to the short to intermediate term maturities rather than long term bonds. For a given change in interest rates, long term bonds will fluctuate in market value much more dramatically than the short or intermediate term bonds. We also dampen the interest rate risk by staggering or laddering the maturities of the bonds purchased such that there will be maturities of bonds in regular intervals from the shortest maturity to the longest maturity. The result is a portfolio that functions as a hedge against the movement in interest rates. Therefore, while it is interesting to note the activity in some exotic corner of the bond market, we are more comfortable collecting the predictable cash flows of a high quality bond portfolio that also provides some measure of stability for the overall value of the portfolio.

 

As 2009 fades away it is kind of hard to remember what all of the fuss was about this time last year. The global financial system was on the brink of collapse. The economy was well into its worst recession in decades. As housing prices sank, many homeowners found they owed more on their mortgages than their homes were worth. Millions of Americans lost their jobs, and even those who didn't, stopped shopping and went to work paying down debt, vowing never to do that again. So what has changed? Well, thanks to lots of money directed by governments to (mostly) the right places, the fear of imminent collapse has abated and the mood has brightened considerably. Indeed, there are early indications that the auto industry and the housing markets to name a few, have begun to put in a bottom. The notion of 'less bad than dire' expectations for corporate earnings, unemployment figures and retail sales has established a psychological floor from which we can begin to pick ourselves up. Global stock markets manifested the mood change by rallying impressively - Russia was up 128% off its March lows, and every global stock market, except Japan, was up on the year. The S&P 500 finished the year up 27% for 2009 including dividends, never looking back from its low set in early March. Notwithstanding this historic run, the S&P 500 now stands around 30% lower than its late 2007 high of 1577. 

As we marvel at the ever changing investment landscape and wonder about what 2010 may hold, we are reminded that events rarely play out the way people anticipate they will.  Meanwhile, investment objectives need to be met and long-term goals realized. To that end, we are encouraged by the fact that the overwhelming majority of the dividend-paying stocks on our approved list actually raised their dividends during 2009. This consistent and powerful factor in our investment process goes a long way toward smoothing out the bumps that we are sure to encounter along the way. We sincerely appreciate the trust that you have placed in Northstar.

 

As many of you may know, starting in 2010, you have the option to convert your traditional IRAs into Roth IRAs. This transaction is commonly referred to as a "Roth conversion."

What's The Difference? With a traditional IRA, you receive an income tax deduction for the money you contribute to the IRA, but then pay income taxes on the value of the money you take out in retirement.  With the Roth IRA, you don't receive a deduction for the money you contribute, but you don't have to pay tax on the money when you withdraw the funds in retirement.

If you convert a traditional IRA into a Roth, you can change a tax-deferred account into one that is tax-free.  But to do the conversion, you must pay income tax on the amount you convert.

Should You Convert? The conversion analysis all comes down to your predictions for future tax rates. Basically, if you believe you will be in a higher tax bracket in the future, you may want to convert today and pay income taxes at today's rates. If you don't believe you will be in a higher bracket, then it doesn't make sense to convert.

For instance, in the above example, you paid an assumed 38 percent tax rate on the conversion.  It would make sense to convert today if you were confident that in future years, you would pay more than 38 percent in income taxes on the distributions from the IRA.

Thus, the decision to do a Roth conversion all hinges on your ability to predict future income tax rates, which is of course challenging. Unless you feel very confident that you'll be in a higher income tax bracket later, it may not make sense to accelerate all those income taxes and pay them years or decades before they're due. You have to weigh the certainty of owing large amounts of taxes today against the uncertainty of your future tax bracket.

Here are a few other things to consider:

There are, however, several situations where a conversion may be compelling:

 

As you can see, there are many variables to consider.

 

Partial Conversion. You also have the ability to do partial conversions. If you aren't confident about your future tax rate, or if you are in a low bracket and want to convert just enough assets to keep you in that lower bracket, then a partial conversion may make sense.

We will be talking to clients about Roth conversion options throughout the year. And if you are in a situation where it might make sense, then we would need to work with your tax advisor to help you analyze the tax costs and benefits. In the interim, if you would like to discuss Roth conversion options, please contact your portfolio manager.