Russell Bailyn -

If you’re a client of mine, or have ever engaged in a conversation with me about managing investments, then you know I’m a big fan of indexes and low-cost investing. I’m still a fan of the occasional manager who consistently outperforms his/her benchmark but I’m still skeptical that it’s worth the added expense over a long period of time. Today’s post is specifically about fundamental indexing. For those of you out of the loop about fundamental indexing, it’s a strategy which equal-weights the stocks in an index instead of weighting the index holdings based on market capitalization. When you weight based on market cap the way major indexes such as the S&P 500 do, your index inevitably invests the majority of its money in the top holdings. For example, the 20 largest companies in the S&P 500 comprise just over 32% of the index. The other 480 stocks comprise just under 68% of the index. While these market-cap indexes may be more accurately reflecting the economy, they may not be helping your portfolio…

The statistics show that fundamental indexing is working. Not only have equal-weighted indexes dramatically outperformed their market-cap peers over the past year, but the past year has been one of the most volatile and treacherous for investors in recent memory. As of 2/25/2010, the fundamental indexing strategy (as measured by the RAFI US 1000 index) has outperformed the S&P 500 by 20.67%. Over two and five-year periods the returns narrow to slightly less impressive but still respectable 10%.

After reading through various reports comparing the two indexing styles, many have pointed out that fundamental indexing comes with a slightly higher degree of risk, as measured by a standard deviation which is 3.3% greater with the RAFI index. So, you would be experiencing a slightly higher degree of volatility when you chop out some of your largest blue-chip stocks.

What can we draw from this comparison? In my practice, I’ve increased my exposure to unique indexing strategies over the years. I haven’t really embraced the really obscure indexing strategies without proven track records yet, but fundamental indexing has been something which I’ve increased exposure to over the years. I would recommend to investors that they consider diversifying their indexing strategy to include both market-cap and equal-weight exposure.

As for the added cost associated with equal-weight indexes; when you’re talking about a jump from .2% to .58% (S&P 500 vs. RAFI 1000 index) you’re not exactly getting ripped off.

Questions or comments? E-mail me.

Russell Bailyn
--
Wealth Manager
Premier Financial Advisors, Inc.
14 E 60th Street, #402
New York, NY 10022
P: 212-752-4343 *231
F: 212-752-7673
rbailyn@premieradvisors.net

Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.

All investing involves risk. One cannot invest directly in an index.

Posted by Russell Bailyn at 12:15 PM | Permalink | Comments ( 0 ) | TrackBacks ( 0 )

Roth IRAs are very trendy right now. “Trendy” isn’t a word I usually use to describe financial products and services but in this case I think it applies. Many investors are so concerned about upcoming tax rate hikes that they are more than willing to forego a tax deduction today if it means not having to worry about rising rates in the future. Starting in 2010, anyone can convert a traditional IRA to a Roth. SEP and SIMPLE IRAs can be converted as well. Before 2010, only individuals with adjusted gross incomes below 100K could do the Roth conversion. So, this opens the door for lots of wealthier Americans to make this switch. No surprise the government is looking for new sources of tax revenue now as they have plenty of fiscal problems to deal with. Below is a list of questions I’ve been fielding regarding IRAs and the Roth conversion.

What are the core differences between traditional and Roth IRAs?

Traditional IRA contributions are always tax deductible if neither you nor your spouse is actively participating in an employer-sponsored retirement plan such as a 401k. So, here’s a simplified example: If you earn $50,000 and put $5,000 in a traditional IRA, you’d pay taxes based on $45,000 instead of $50,000. This can increase your tax refund if you have substantial tax withholdings from your gross pay. Again, the main benefit with a traditional IRA is a tax deduction now, and you pay income tax on your money when you eventually take distributions, presumably later on during retirement.

Roth IRA contributions are made on an after-tax basis and are not taxed when withdrawn. So you don’t get the tax benefit now, you get it later. Like a traditional IRA, Roth IRA investment earnings accumulate without having to pay current taxes on them. However, as opposed to a traditional IRA, qualified withdrawals of Roth IRA earnings are tax free.

Why would you want to convert to a Roth IRA?

A Roth IRA can provide tax-free income after you retire. And, unlike distributions from a traditional IRA, qualified Roth distributions are not included in income for purposes of determining whether Social Security benefits are taxable. Also, traditional IRAs require distributions once the account holder reaches age 70 ½, increasing the likelihood that Uncle Sam can take a bite out of your earnings while you are still alive. Roth IRAs do not have minimum required distributions, allowing the account to (hopefully) grow on a tax-deferred basis for longer. Beneficiaries do have to take distributions but those are still not subject to income taxes so long as the Roth has been in existence for 5 years.

What are the tax consequences of converting a traditional IRA to a Roth IRA?

This is the sting. When you convert to a Roth, any deductible contributions you made and any accumulated earnings in the traditional IRA become taxable. However, even if you’re younger than age 59 ½, you won’t be liable for the 10% early withdrawal penalty on the conversion. Lucky for investors, if they convert in 2010, they can split the tax bill over two years, 2011 and 2012. This may soften the blow a little for taxpayers and make it possible for some less wealthy investors to convert to a Roth. You don’t have to split the tax over two years but you have the option.

Who should consider a Roth IRA conversion?

Like most things in this business, the conversion decision is very personal because everybody’s situation is different. In general, you will likely benefit from a Roth IRA conversion if:
• You think you’ll be in the same tax bracket or higher in the future—even when you retire.
• You have a low account balance now but expect the value of your account to be significantly higher in the future.
• The younger you are, the more likely you are to benefit (time value of tax-deferred investment accounts).
• If you don’t think you’ll need all of your retirement savings, converting to a Roth could potentially allow you to provide your beneficiaries with tax-free income.
• If you have the resources to pay the conversion tax not out of your IRA. This is why people with savings outside of their IRA accounts (generally people with slightly higher incomes) will often stand to benefit more from the conversion.

What if I convert and then my account value drops?

This is an important question to answer because it poses what could end up being an unfortunate scenario. Let’s say you convert 50K and then your account value drops to 40K, you would indeed have to pay income taxes based on the balance at the time of conversion (50K). If it drops and you change your mind about the conversion, you can recharacterize back to a traditional IRA and no longer owe tax on the conversion. For this reason, it makes sense to wait until the latest possible date to covert. Recharacterizations can be processed until October 15th of the year following when you convert.

Because going through the Roth conversion will increase your tax bill, consider the effect it may have on your overall tax situation. You may have other credits/deductions which you can’t take as a result of pushing your AGI higher with the conversion. I know that’s a tricky thing to think about, but programs like Turbo Tax makes it easy to try various scenarios and see what works best for your situation.

Questions or comments? Feel free to call or e-mail me.

Russell Bailyn

--
Wealth Manager
Premier Financial Advisors, Inc.
14 E 60th Street, #402
New York, NY 10022
P: 212-752-4343 *231
F: 212-752-7673
rbailyn@premieradvisors.net

Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.

Posted by Russell Bailyn at 03:53 PM | Permalink | Comments ( 3 ) | TrackBacks ( 0 )

I’ve written at length about problems within the retirement plan system here in America. Perhaps the biggest drawback for employees is that those secure pensions of the 80’s and 90’s are, for the most part, being replaced by employee-funded 401(k) and 403(b) plans. While it may seem like only an operational switch, it’s actually a huge downgrade for most employees. Instead of having definite figures to rely on for future financial security, workers have to rely on themselves to save and the markets to make their savings grow. As we’ve seen over the past decade, the markets don’t always do us favors. Most investors, especially those nearing retirement, would have been better off putting that money into a bank account with little or no interest from 2000 to now. That would at least have eliminated the panic and emotional madness which most investors have been experiencing. Since we can’t predict what the markets will do in the future and trillions of dollars remain in retirement plan investments, the best we can do is hope for some real and genuine reform:

Of all the areas which deserve reform within the retirement plan industry, disclosure of retirement plan fees should be high on the list. Many participants have no clue about what costs they pay to participate in and maintain retirement plans. Those costs are well hidden beneath secretive “expense ratios” and blended into the daily pricing of many investments which we think is only reflecting market performance. Sneaky, sneaky! Fortunately, some members of government are working to resolve these problems by way of H.R. 2989 (The 401k Fair Disclosure and Pension Security Act). This badly needed legislation would do the following:

• Require 401(k) plans to disclose fees in one dollar figure taken from participants accounts in a worker’s quarterly statement;
• Require 401(k) service providers and plan administrators to disclose fees charged on 401(k) plans broken down into four categories: administrative fees, investment management fees, transaction fees, and other fees;
• Help workers understand their investment options by providing basic investment information, including information on risk, return, and investment objectives;
• Require plan administrators to offer at least one low-cost index fund to plan participants in order to receive protection against liability for participants’ investment losses;
• Require service providers to disclose financial relationships so companies that sponsor 401(k) plans can make sure there are no conflicts of interest;
• Ensure that if workers get investment advice through their jobs, that advice be based on the workers’ needs – not the financial interest of those providing the advice;
• Provide adjustments to pension funding rules to ensure plans can weather the economic crisis without being forced to choose between cutting jobs or freezing plans.

Something else which would greatly benefit retirement plan participants would be clearer rules on investment advice. As the system currently stands, most investment advice is provided by the same insurance and fund companies which administer the plan (basically wolves in sheep’s clothing as FA magazine so aptly calls it). Participants should recognize this clear conflict of interest and seek advice from independent, unbiased third party providers.

Any hope of serious reform depends to a large extent on what else is on the docket for lawmakers in the coming months. If health-care remains the focus, it means less time, attention and dollars dedicated to the retirement system. If Republicans win some seats in the mid-term election that could also stall retirement plan reform. No matter what, let’s hope the Department of Labor recognizes the awful position so many Americans are in right now when it comes to their retirement plans and tries to bring a little common sense into the system.

Questions or comments? Please e-mail me.

Russell Bailyn

--
Wealth Manager
Premier Financial Advisors, Inc.
14 E 60th Street, #402
New York, NY 10022
P: 212-752-4343 *231
F: 212-752-7673
rbailyn@premieradvisors.net

Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.

Posted by Russell Bailyn at 01:28 PM | Permalink | Comments ( 2 ) | TrackBacks ( 0 )