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The Age of Wonder
"The Age of Wonder" is what English historian Richard
Holmes called the period between Captain Cook’s first
voyage in 1768 and the sailing of Darwin on The Beagle
in 1831. In that period scientific experimentation and
exploration produced a wondrous new understanding of the
physical world. Mungo Park explored Africa and Joseph
Banks circumnavigated the world with Captain Cook.
William Herschel scanned the skies, discovered Pluto and
then went on to build the first forty-foot telescope, a
wonder of the age. French aeronauts ascended in hot air
balloons drawing crowds as large as 250,000 to the
Tuileries Garden in Paris. It was an age of optimism
that looked to the future with expectation.
Today we live in a new age of wonder. In contrast to
the earlier age, ours is marked by anxiety about the
future. The great Obama experiment promises to bring
government intervention and regulation into our lives to
an unprecedented degree. The crushing weight of
government expenditure and debt makes us wonder what the
future will bring for our children. Unlike the baby
boomers who have enjoyed a standard of living higher
than their parents, we wonder if the same will be true
for future generations. We wonder whether America will
be able to maintain its place in the world, projecting
influence in support of its ideals. We wonder what is
going to create wealth if it is confiscated by high
taxes and consumed by entitlements. As Margaret Thatcher
famously said, “The problem with socialism is that
eventually you run out of other people's money to
spend.” We wonder if the great American experiment is
beginning to consume itself.
* * *
Despite these gloomy thoughts, the stock market
continues to rally on the growing consensus that the
economy is picking up and that a new downturn is
unlikely. Though still below pre-crisis levels,
corporate profits are strong especially compared with
the dismal reports of a year ago, helping fuel stock
gains.
One cause for optimism is that individual investors
remain skeptical of stocks. Should that change, a flood
of money into equities could keep the rally going longer
than would otherwise be sustainable. For now, though,
investors appear to be very underinvested in equities,
preferring bonds for their supposed safety. We consider
the perception of bonds as safe to be illusionary.
Yields are to our mind unattractively low and bonds with
maturities greater than five years are very vulnerable
to inflationary pressures that are sure to arrive
eventually in the wake of high government deficits.
Furthermore, in 2011 the Bush tax cuts expire and top
marginal tax rates will rise, taking a further chunk out
of pre-tax interest earned. And tax-free municipal bonds
are not necessarily an answer. High-tax states like New
York and California are struggling with huge deficits
too, which raises questions about the quality of their
debt. Caveat emptor.
Year-to-date, clients have enjoyed robust
performance. Yet we are cautious in our outlook for the
market. It has led fundamentals on the way up. Now that
fundamentals are looking better, what can the market
look forward to?
We are trying to remain disciplined by not selling
stocks just because they have gone up. Nonetheless, we
do have opinions on what our stocks are worth and will
take profits as they approach those targets. We also
note, unless Congress acts, next year Federal taxes on
qualified dividends will once again be taxed as ordinary
income with marginal rates as high as 39.6% compared to
a flat 15% rate now. This makes dividends substantially
less valuable. We may well lighten up on stocks that are
owned primarily for dividends.
* * *
There has been much discussion in the financial press
recently about converting a traditional IRA to a Roth
IRA. Like a traditional IRA, a Roth enables investors to
earn investment income and take capital gains without
paying taxes. Unlike a traditional IRA, a Roth enables
investors to take distributions without paying future
income taxes as well. Herein lies its appeal. Once a
Roth is established it is truly a tax-free investment
vehicle providing tax-free distributions…unless at some
later date the government changes the rules, a not
unlikely outcome.
We consider conversion to be attractive under certain
circumstances.
If you do not intend to spend the money in your Roth.
Once you convert, you cannot withdraw money from your
Roth for five years without penalty.
If you have heirs to which you intend to leave the
Roth. The Roth is particularly attractive as an
estate-planning tool. By leaving a Roth to the next
generation, which has a much longer investment horizon,
the value of investing tax-free is magnified
tremendously. If you are relatively young, that enhances
the value even more.
If you can afford to pay the substantial up-front
tax. Converting to a Roth is considered a full
distribution for tax purposes and therefore the whole
value of your IRA is considered taxable. So there is a
large up-front tax payment. For many people, this will
put them in a high tax bracket for the year in which
they convert, resulting in an especially large tax
payment for that year. We note that for conversions made
in 2010 only, the tax can be paid over two years.
If you are interested in the possibility of
converting your traditional IRA to a Roth, we would be
glad to discuss it with you in further detail and answer
any questions you may have.
Tom
Herzig
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