BURT ASSOCIATES, INCORPORATED-6010 EXECUTIVE BOULEVARD #900-
Volume 11 Issue 2 www.burtassociates.com October 2001
LONG-TERM VERSUS SHORT-TERM
By Dr. Marvin R. Burt, CFP™
It is tempting to focus exclusively on the next few months, instead of the next few years. Unfortunately, such a short-term focus can lead to investment mistakes that can prove to be very costly. There are reasons to be cautious in today’s environment. The tragic events of September 11 have worsened what was already a weak economy. It is likely that the economy will weaken further in the near term and we will probably experience two quarters of negative growth. Additional terrorist attacks could cause further short-term disruptions.
However, there are strong fundamental strengths that will probably trigger a strong rebound in 2002. These include an expansionary fiscal policy, including tax cuts and increased government spending, lower interest rates, low inflation, and significant pent-up demand that recessions produce. Because of these factors, the economy may act like a coiled spring that should bounce back very sharply. It is very important to be well positioned to take advantage of this expected rebound. The stock market normally anticipates a recovery by about six months. We must be positioned to participate in the recovery well before it actually occurs. Therefore, instead of being overly focused on the short-term problems, we must focus instead on the recovery that will inevitably occur at some point.
Accordingly, we are holding the course and believe our portfolios are well structured to participate in the recovery. At the same time, we continue to be well diversified in bonds and cash equivalents, which have protected us very well from the stock market correction.
Fred Cornelius, CFP,CFA
draws on history to demonstrate the importance of being positioned to
participate in stock market rebounds and the futility of attempting to time the
stock market. Maria Cornelius, CFP
describes our process for selecting and monitoring mutual funds and managers in
achieving superior risk-adjusted performance in the stock market. Chris Rhim, CFP discusses the extraordinary
performance of bonds and the prospective changing landscape as we go
forward. Changes in the tax law are
analyzed by Christine D’Amato, CFP and some significant areas for planning are
discussed. The only certain thing about
our tax laws is that they will change and some significant changes are
imminent.
|
INSIDE The
Stock Market Is Not a Patriotic Animal
2 Mutual Fund
Selection and Monitoring Process 3 The Bond
Market
4 New Tax
Law 4 Section
529 College Savings Plan 6 Practice News
6 |
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The
Stock Market Is Not a Patriotic Animal
By Fred Cornelius,
CFA, CFP™
Words cannot do justice to the events of September 11, 2001. As human beings, we will be dealing with the psychological issues and loss of life for many years to come.
However, as investors, we are fortunate that the stock market over the long run is neither emotional nor patriotic but cold and calculating. While we might revile any individual for having these qualities given the recent events, these are the exact qualities that will enable the stock market to lead the economy out of recession and into recovery. These traits are important because they provide investors the ability to once again make educated and informed decisions based on fundamentals and research. The problem we have faced since the attacks is that the stock market can act very emotionally and unpredictably over the short run. We will resist the natural tendency to make investment decisions based on emotions but instead base our strategy on solid fundamental principles of investing.
The following is an
analysis, which illustrates that holding equities through a crisis has rewarded
long term investors. The table, which
analyzes past performance following either tragic
events or market crashes, points out that investors who missed the five best
trading days during the year following a tragic event significantly under
performed the market. Here's how the
data looks if you owned the Dow stocks:
Event
|
Rate of Return 1 year Following
Event |
Rate of Return 1 yr. After
Event if You Missed Best 5 Days |
Benefit
from Holding Stocks
|
|
|
7.0% |
-8.4% |
15.4% |
|
Desert
Storm |
25.5% |
9.7% |
15.8% |
|
1987
Market Crash |
23.1% |
-6.8% |
29.9% |
|
Cuban
Missile Crisis |
25.9% |
14.2% |
11.7% |
|
|
2.2% |
-8.2% |
10.4% |
Many confident investors feel that it would be highly
unlikely for them to miss all five of the best trading days in a given
year. One thing that you must remember,
though, is that when the market makes a big move to the upside during tragic
periods, it is due to hot news being released.
Hot news works for investors who are already positioned in the market,
not for those who try to buy after the news is out. The reason for this is that stocks will
experience order imbalances and gap up before you can jump back in. It will
take time, but the economy and the stock market will recover. The key is to be in the market when things
improve; otherwise, you risk missing large moves to the upside. ■
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3
Mutual Fund Selection and Monitoring Process
By Maria G. Cornelius, CFP™
We are entering a period when the only thing we
can really count on is that everything in the US
Selection Process
Selecting a new fund for the portfolio entails a lengthy
process of screening followed by an evaluation by our Investment
Committee. We start by screening over
10,000 funds for funds that meet our minimum criteria. For example, we will only consider funds that
have a track record of 5 years with the current portfolio manager or management
team, no sales commission of any kind, a risk profile that we find acceptable,
and good long term performance when compared to other funds with the same
characteristics. Further, we look for
funds that are not heavily concentrated in one industry, that have a reasonable
turnover rate, and a low expense ratio.
We also look carefully at a fund’s cash position and will not consider a
fund if the manger is holding 15-20% of the portfolio in cash since this
indicates that the manager is trying to “time” the market. In addition, we will not select a US fund
that holds more than 9% in foreign stocks, since we would prefer to get our
international exposure through funds that specialize in this area.
Once we have narrowed the search down to the most attractive 5-6 funds, we do a much more detailed analysis by requesting detailed information from each of the fund companies. We contact the portfolio management team with questions or to clarify certain issues. When 1-3 funds have been identified as the best choices, each of the planners in the firm evaluates the funds, and an Investment Committee Meeting is held to make a final decision.
Monitoring the Portfolio
Even though our emphasis is on the long-term
performance of our funds, we do evaluate the relative performance of each of
our funds on a monthly basis. Equally as
important, we have established “alerts” using many of the screening criteria
described above, which allows us to run a monthly report to determine if any of
the funds have “violated” one of our set criteria. For example, we will be alerted if any of the
lead portfolio managers has changed, if the allocation to an industry sector
exceeds our specified threshold, or if the risk in the portfolio (measured by a
number of statistics) exceeds our comfort level. This is an extremely valuable tool that
helps us to
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evaluate changes in the individual funds. When we have concerns about a fund, we set up a conference call with a member of that fund’s portfolio management team who can address our concerns.
We continue to find new ways to improve on our
process as technology changes. We are
committed to maintaining a portfolio of high quality funds with attractive
long-term performance and an acceptable level of risk. ■
The Bond
Market: Past Performance &
Anticipating the Future
By Chris Rhim, CFP™
As the equity markets continue to gyrate, bonds have
been the success story of the past two years.
A total of nine interest rate cuts in 2001 by the Federal Reserve has
allowed most bonds to appreciate. Recently, the flight to quality has
accelerated, significantly boosting our returns. Tax-free municipal indices
have returned between 5-6% year-to-date while mortgage-backed securities like
Ginnie Mae (GNMA) have returned at least 7.5%.
Government Treasuries were affected
the most by the terrorist strikes with investors demanding the safety of
US government-backed bonds.
Intermediate-term government indices are up over 8.5%. High quality, investment grade corporates have
also performed well, returning over 8% as measured by the Lehman Brothers
Aggregate Index. These bonds are the
right place to be since even money market funds proved to be no safe harbor:
yields on most money market funds have recently fallen below 3%.
While we remain confident our bonds will continue to do well, we are also preparing for economic recovery, which we believe should happen sometime next year. A recovery in stocks encourages rising interest rates that can hamper bond performance. One reason Treasuries performed well last year was due to government surpluses and less issuance of longer-dated debt. Today, the Federal government, in attempting to jump-start the economy, is considering further tax-cuts and increased spending for domestic consumption and military needs. This will cause the government to borrow more (i.e., issue debt), which places pressure on the prices of existing bonds. States and municipalities (such as Virginia) have seen their tax receipts drastically reduced in the face of job losses, rising unemployment and reduced economic activity. We anticipate they too will tap the debt markets to offset this lost revenue. Mortgage refinancing due to lower interest rates will cause reevaluation of these securities. Mortgage securities tend to perform best in stable to slightly rising interest rates. All of these factors we view as catalysts for changing the bond landscape we have known for the past 20 months.
As investment professionals,
we know that the stock and bond markets typically lead any real changes in the
economy. This means we have to recognize
the signals that lead us to alter our strategy. The bond market’s extended run in 2001 was lengthened
by the unanticipated events of September 11.
However, we do not believe the next twelve months will resemble the
previous twelve in terms of how we view the investment opportunities that lie
ahead. As always, we will be
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making changes in our strategy over time. Should you have specific questions, do not
hesitate to contact your investment advisor. ■
Planning In Light
of the New Tax Law
By Christine A. D'Amato, CFP™
The Economic Growth and Tax Relief Reconciliation
Act of 2001 (the Tax Act of 2001), enacted into law by President Bush on June
7, 2001, includes many sweeping changes to income taxes, retirement plans,
education plans, and estate taxes. As a
result, frequent evaluation, increased planning and possible adjustments will
need to be considered by all clients and their advisors.
Over the next nine years, the Tax Act of 2001 lowers income tax rates (but unfortunately increases the Alternative Minimum Tax effect), increases retirement plan contribution amounts (albeit slowly), increases the estate tax exemption amount, lowers the estate tax rate, lowers the gift tax rate, increases the generation skipping exemption amount, lowers the generation skipping tax rate, and improves the tax benefits of education savings plans, to name a few. Most provisions start in 2002 and end after December 31, 2010 when the Tax Act sunsets.
Given the complexity of the new law, we recommend a
review of your estate documents and your tax planning. A thorough review should cover current and
future gifting plans, allocation of current assets, distributions to heirs,
appropriate beneficiary designations (including contingent beneficiaries) and
flexibility for executors and trustees.
Formulas in wills and trusts will need to be reviewed, especially if the
language refers to the "maximum federal unified credit or exemption
amount" or even a specific dollar amount.
Since the exemption amount will be rapidly increasing to $3.5 million by
2009, an entire estate could be inadvertently directed into a trust, for
example, leaving little or no assets outright to a surviving spouse or
children.
Other important areas of planning under the new Tax Act include:
● Deferring income to lower tax years and accelerating deductions to higher tax years
● Considering maximizing contributions to Education IRAs and/or Section 529 college savings plans
● Contributing the increasing amounts to retirement plans, including the special catch-up amounts for age 50 or older participants
● Carefully considering life insurance needs and resisting buying term insurance in anticipation of the estate tax repeal (which is in effect only during 2010 under the Tax Act)
● Maximizing gifting strategies, especially since the gift tax exemption amount is not repealed and will remain at $1.0 million starting next year
● Monitoring changes in state laws since revenues will be lost as the federal credit for state death taxes is phased out
● Reviewing older Generation Skipping Trusts (GSTs) and considering creating new trusts, especially if the exclusion ratio is more than zero but less than one
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● Reconstructing and maintaining basis records to prepare for the possibility that the step-up basis will be eliminated and the modified carryover basis method is put in place (as occurs only in 2010 under the current law but has political support in Congress)
One thing is almost certain given our current
economic and political environment: there
will be further congressional action that will modify, extend or even repeal
various provisions of the Tax Act of 2001.
Legislation is already pending that will change parts of the current law
and will make ongoing planning even more important. Contact your advisor with any questions or
concerns and to start a review of your financial future. ■
Section 529 College Savings
Plan
We are still waiting for Maryland to implement their
Section 529 college savings plan. It now
appears that it might become operational in November. We will notify our clients who have expressed
an interest in the plan when it is available and our assessment of its merits
compared to other available state plans. ■
