In This Issue

Squeals of Market Angst

Focus on the long-term, try to tune out day to day noise.

Making Sense of the Noise

Roth Conversion

Red Lighthouse Investment Management

Squeals of Market Angst

During the last two quarters, much of the discussion in the financial press centered on Greece, and its possible bankruptcy.  Some other European countries that use the Euro as their currency, including Spain, Ireland and Portugal, were also under scrutiny.  The media followed by coining the catchy term PIGS (Portugal, Ireland, Greece, Spain) as an acronym for those countries whose lack of fiscal discipline resulted in their being singled out and “punished” by the markets. 

All this talk of fiscal imprudence sounds all too familiar.  A mere 15 months ago, some people were predicting the impending doom of the equity markets and the next Great Depression.  Many pundits argued that inflation was set to accelerate (shorting the long bond was considered a sure thing) and that the US dollar would tank.  Since then, the S&P 500 is up over 50% and the MSCI Emerging Markets Index is up over 80%.  Bond prices have strengthened as has the dollar.  So much for the pundits’ predictions.  This is not to say that the US Dollar won’t come under pressure.  The fact is, no one knows.  Trying to predict currency movements, like trying to pick individual securities, or sectors, is more likely to result in disappointing results.  It is far better to establish an asset allocation consistent with one’s risk/return preferences.  Investors who remain disciplined with respect to their investment approach are likely to get rewarded over time.  Not panicking when market volatility increases should be one of the important lessons learned over the last couple of years.  Unfortunately many investors did panic near the bottom of the cycle and were unable to benefit from the market’s subsequent upsurge. 

This is not to say that there aren’t serious fiscal imbalances in many parts of the world.  We can hope that the problems of Greece serve as a wake up call to other countries, including the US, who are in need of getting their fiscal homes in order.  We can also hope that the current mess in the Gulf of Mexico helps to highlight the need for a sound long-term energy policy. 

         Making Sense of the Noise

Looking at the graph of stock returns over time (above), it can be hard to see an upward trend.  There is so much random noise.  Indeed in any statistical analysis it is important to separate the noise from the factors that are driving performance.  Investors need to focus on the long term, recognizing that short-term volatility (risk) is the price one pays for investing in stocks. 

Historical Perspective

One way to keep risk in perspective is to look at annual returns, in this case since 1926.  The chart below shows the historical distribution of returns.  The years are stacked in ascending order grouped by the range of returns. 

What can we conclude?  

• The last two years have been extreme by historical standards.  In 2008, US stocks experienced their second-worst annual return since 1926.  A year later, in 2009, stocks provided investors with a top quartile return.
• Over the long term, the market has shown more positive years than negative ones.  Since 1926 almost three-quarter of the calendar years have been positive.
• Not only have there been more positive years, there has been a larger concentration of performance in the higher ranges of returns.
• There seems to be no discernable pattern.  Good years can be followed by poor ones and vice versa.  The returns appear random, illustrating the futility of trying to time the market.

Over the long term the market has rewarded investors who can bear the risk of stocks and stay committed through various periods of performance.

          Roth Conversion

As part of the Tax Increase Prevention and Reconciliation Act (TIPRA), income limits for conversions to Roth IRAs have been eliminated.  While Congress passed TIPRA in 2005, the income limit repeal only took effect this year.  Why should one consider converting traditional IRA assets to a Roth IRA?  There are several potential benefits.  Withdrawals from Roth IRAs are tax-free, as long as certain holding periods are met.  Additionally, compared to traditional IRAs, Roth IRAs require no minimum distributions.  Therefore, the money can continue to grow tax-free.  Lastly, since taxes are already paid with Roth IRAs, the beneficiaries of Roth IRAs owe no income taxes. 

While conversion is a move that should be considered, there are many unknowns, e.g. future tax rates, which could make it difficult to assess if a conversion is likely to be the best decision.  Of those who do choose to convert, some elect to convert only a portion of their assets.  Others prefer to convert the whole balance but do so over multiple tax years. You should consult your tax advisor to discuss whether converting some or all of your traditional IRA assets to a Roth IRA makes sense for you.  This is but a short overview of the issues to consider.  We would be happy to discuss this in more detail with you in person.                                                                               

         Red Lighthouse Investment Management

Red Lighthouse relies on referrals to help grow our business.  We are grateful to our clients for their support and trust as our assets have grown meaningfully over the last 12 months. We have also developed an institutional side of the business, and are in the process of completing a consulting project for a defined benefit plan.  We continue our policy of taking clients on a referral basis. 

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