Taxes & Alternatives to Shape Your Investment Planning

What do you do now?

April 10, 2010

Understanding where we are today in investments Alice: Would you tell me, please, which way I ought to go from here?

The Cat: That depends a good deal on where you want to get to.

Alice: I don't much care where.

The Cat: Then it doesn't much matter which way you go.

Alice: …so long as I get somewhere.

—Lewis Carroll

Why did God create economists?To make weathermen feel good about themselves!

Where are we today on investments?

• Starting the decade Started with $100• Jan 2000 – Sept 2002 Down 42% $58• Oct 2002 – Dec 2006 Up 88% $109• Jan 2007 – March 2009 Down 45% $60• March 2009 – Dec 2009 Up 55% $92• Jan 2010 – Mar 2010 Up 5? $96

– Net return really stinks(technical term)

– We are expecting a 20% pullback from 1/1/2010

The issues in the economy

• Ballooning federal deficits• Overheated China• Inflation and higher interest rates• High unemployment and debt-laden populace• Poor administration policies• Hostile business environment• Nuclear Iran – continued issues in Afghanistan and Iraq

What the economy is telling us

• Economy is growing – very slowly off the bottom • Job growth is starting – really slowly• Earnings – stabilized and are growing

– Possibility of explosive growth in recovery• Inflation – low and likely to stay low for a long time

– Wages are two-thirds of costs and there is excess• Interest rates – long-term rates are not low (only short-term rates

are low) … they will be kept that way for two years to support the housing market mortgage reset, but then they will rise in the long-term

• Risks are still high – see prior slide

Thoughts on future economic news: My 1/17/09 predictions from last year

• The jobless rate will increase to over 10% – right• Home real estate prices will continue to go down 30-40%

overall – right• Commercial real estate will tank in 2009 and 2010 – starting• There will be 15-25% bankruptcy in retail businesses – too high• Oil will drop below $30 a barrel – got to $37• Commodities will continue to decline – correct (except gold)• Credit default swaps are a $30 trillion hidden risk – being worked

out – structural weaknesses saved by gov’t too big to fail • There will be more national bankruptcy issues – right

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Current Income Tax Update and What is Going to Happen

in the Future

Current tax issues and expected changes

• The estate tax has phased out for 2010, but it might come back with more of a vengeance than anyone ever guessed

• More taxes on business; bank tax is first of many• Healthcare reform will fail (thankfully) – guess I was wrong• Stimulus will keep backing automotive industry and the

housing market • State taxes fees, etc. are likely to increase further

Convert regular IRA to a Roth IRA: Opportunity or trap? The rules …

• 100% of growth is tax-exempt• No required minimum distributions (RMD) at age 70½• RMDs on inherited Roth IRAs• $100,000 modified adjusted gross income (MAGI) limit• Starting in 2010, the $100,000 MAGI no longer applies• The taxable income recognized on a Roth IRA conversion in

2010 may be spread over the following two tax years (i.e. 2011 and 2012)

Convert regular IRA to a Roth IRA: Opportunity or trap?

• Good idea – Have excess assets to pass without ever needing to spend the money– Have a large estate tax liability – estates over $10MM – Have a net loss or other deductions you can use up– Must be able to pay the tax from non-Roth funds

Convert regular IRA to a Roth IRA: Opportunity or trap?

• Bad idea … for most people, despite what you might hear– If your income is going to decrease in retirement– If you need to use the IRA in retirement– Question: Can you trust the government to never tax a Roth IRA?

• Planning – option to recharacterization back to regular IRA– If values go down or you just change your mind

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Ideas on “Savvy” Investing

What you should buy now:Last year’s recommendations

Nuveen Premium Income Fund (NYM) 2009 return – 48.37%

ING Managed Risk Nat Resources (IRR)2009 return – 43.84%

ING Global Equity Dividend Fund (IGD)2009 return – 48.35%

Overall, we were correctly conservative through the crash and too conservative coming out of it.

Your asset allocation

• Conservative investor who historically invested 60% in stocks and 40% in bonds

• Last year, recommended you should be 20% stocks, 70% higher-quality corporate or muni bonds or alternative strategies and 10% in short-term CDs (good place to park)

• When you see the light at the end of the tunnel (and you are sure it is not a train coming your way), move stocks up to 40%, reduce high-quality bonds to 30% and increase lower-quality bonds to 30%

• Today … high-quality short-term bonds 30%, mortgage REITs 10%, equities 30%, alternatives 30%

Fixed income investment thoughts

• Get your money our of money market funds – no return– MMF had grown from $7B to $10B during drop and decreased by

$300MM over last 9 months • Invest in high-quality short-term corporate bond fund or similar quality

short-term municipal bond fund – Yields are 3%+ in tax free and 4%+ in taxable funds– Do the income tax rate analysis; don’t be lazy– Risk spreads have returned to below long-term averages and the

economy is not yet fixed – Examples: FPNIX, IPFIX, STSMX, EMUNX

Fixed income investment thoughts

• Credit spreads back to normal … WHY????– Sell junk/low-quality bonds; 2200 spread now 600, below LT average – Defaults are increasing but have not hit a high

• Sell long-term bonds; rising interest rates within the next 2 years• Sell closed-end bond funds where the discounts have closed • International bonds being hit by sovereign risk – stay away for now; watch

out for continuing run in dollar off its lows • Buy municipal bonds – ratio of muni yield to Treasury is at 92%

– Stay away from Florida and California – Use national funds, not MD

Fixed income investment thoughts

• For the aggressive portion of your portfolio• Buy residential mortgage REITs

– Yields are very high and leverage is low vs. historical averages

– The companies mostly own gov’t guaranteed mortgages – Look for rising short-term interest rates as the signal to sell– Ex: Annaly (NLY), MFA, Anworth (ANH) Chimera (CIM)

• Look for increasing spreads in closed-end funds during market pullbacks and times of stress

Equity investment thoughts

• All equity market classes move together – lowest correlation is 73%, meaning you get little protection from diversification, but the right sector does add return; international stocks are no different

• Valuations are high but not expensive; the problem is no growth

Equity investment thoughts

• Where are we from the low and the high in the market & where are they valuation wise (current P/E 20 yr avg., PE & %)

• As of December 31 – Large Growth up 66% net down 18 % 18.6/24.1 78%– Large Value up 73 net down 30 16.9/15.4

109%– Small Growth up 81 net down 23 19.0/21.4 89%– Small Value up 88 net down 23 15.4/15.4

100%– International up 74 net down 27 on historic averages– Emerging Markets up 109 net down 27 on historic averages

Equity investment thoughts

• Wait to buy half at 10% drop and second half at next 10% • Buy high-quality large cap high-quality companies

– Energy, healthcare, consumer staples, technology• Buy emerging markets funds• Buy small growth companies• Buy healthcare closed-end funds

– H&Q Healthcare Investors (HQH) & Gabelli (CRX) • Buy business development companies

– First Street Capital (FSC) & Ares Capital Corp (ARCC)

Alternative investment thoughts

• Includes REITs, commodities, long/short, hedged equity, merger funds, arbitrage, gold, option and multi-strategy approaches

• Alternatives are the only non-equity correlated class of investment – correlation factor of .35

• Goal: make 8-12% a year with much less risk than traditional long equity

Alternative investment thoughts

• Gateway Fund (GATEX) options strategy• Merger Fund (MERFX) and Arb Fund (ARBFX) invests in

spreads in traditional corporate acquisitions• Diamond Hill Long Short Fund (DHLSX) uses the long short

approach to control market risk• Calamos Market Neutral Fund (CVSIX) is a multi-strategy fund• Osterweis Strategic Income Fund (OSTIX) is a multi-strategy

income and appreciation fund • I hate gold and think oil is high right now

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Questions?David Goldner, CPA, CFP, CVA

dgoldner@gma-cpa.com | 410.685.5512 | www.gma-cpa.com

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