Here’s an article we recently mailed to our clients, addressing some of the topics that might also be on your mind:

We talk to clients constantly, in person and on the phone, about their money, their worries, their dreams and their lives. Some themes of these conversations rarely change. Do I have the right mix of investments? Can I really afford to retire? Why is this or
that happening to my account?

But many of our day-to-day conversations with clients also reflect the changing times in which we all live. One year ago we hit the bottom of an awful stock market cycle, and some people were seeing their hopes and dreams dashed by forces they couldn’t understand. Now, after last year’s robust market rally and the relatively calm climate so far
in 2010, the conversations probably are different. What is on our clients’ minds these days?

TYLER: It’s true that the worries over the market have abated somewhat. One of the biggest topics people want to talk about is the Roth IRA conversion.

ROTH IRA CONVERSIONS

ERIC: There’s been a lot of recent attention to this in the media because the tax law allows conversions to Roth IRAs during 2010 without the strict income test that applied before.

(Editor’s note: An article on this subject by Merriman advisor Phuc Dang is available online)

ERIC: In reviews, I will typically spend some time going over a client’s circumstances and how they might apply to a Roth conversion. To benefit from this, you must have money in a taxable account from which to pay the taxes. But many people have only tax-deferred investments.

All the scenarios that make a Roth conversion look attractive are based on assumptions of a rate of return that will over time repay the tax cost. And those are only assumptions, not facts.

TYLER: A lot of clients have studied the issue and concluded that they don’t want to convert. It comes down to a tax gamble; most people don’t want to pay taxes now for the possible but uncertain opportunity to save taxes later. One of the big benefits of a Roth IRA is the ability to leave money in a form that the next generation won’t have to pay any tax on it. But if you do that you are in effect pre-paying the tax liability of your heirs. That’s nice for your heirs, but it may not be your top priority.

MARK: There’s lots of confusion on this topic, but in the end when you convert a traditional IRA to a Roth, you are locking in a certain tax cost now for an uncertain later benefit that’s unknown. For the majority of clients, a Roth conversion is not suitable. Maybe 5 percent of them should do it.

TYLER: This is a great tax-saving opportunity for young people who have low income now, either because they are just starting out or because they’re temporarily unemployed. Some parents and grandparents have offered to pay the tax liability, and in the right circumstances that can be a very effective way to give money.

FUNDADVICE.COM: So the bottom line seems to be that converting a traditional IRA may be a good opportunity for people in special circumstances. But for most people, it doesn’t have a known payoff that would make it worth the tax cost. What else are our clients asking us about these days?

FEAR OF INFLATION

MARK: I hear this one a lot: People are concerned that their investments are in danger from inflation, the government in Washington and the national debt. They ask: “How am I protected against these things? Shouldn’t I buy gold and commodities?”

An article available online by Larry Katz (Merriman director of research) is very good on this point. Gold and commodities aren’t necessarily the panaceas that many people think.

TYLER: Some people are frustrated that our philosophy is not designed to change radically in response to changes in the economy. We take a long-term view that we believe will work well. But sometimes it requires a lot of patience.

ERIC: The best time to address these concerns is when we’re constructing a portfolio. We build in our protections in advance, not in reaction to things as they happen.

MARK: Our goal is always to get people a real rate of return in excess of inflation. We have to walk a fine line because there are two big potential problems. One is inflation, and the answer to that is having equities. The second is bear markets, and the answer to that is having fixed-income funds. Both of these potential problems are real, and you are asking for trouble if you’re obsessed with one and forget about the other. Making wholesale shifts in the portfolio based on the issue of the day is just the wrong thing to do.

ERIC: That’s right. We often have to remind clients that their portfolios have a significant exposure to gold and other commodities. I can show them this, and still sometimes people want us to double-up on some kind of asset that they think will be particularly good to deal with whatever is in the forefront. But if we do that, we are always going to be spinning our wheels. Once it is all over the news, it is too late. And no matter what you see or hear or read, we still don’t know what is going to happen.

MARK: I was having this conversation recently with a client who was extremely concerned about inflation and wanted to go completely to fixed-income. Eventually I got him to understand that equities are necessary to protect investors against inflation, and that going to an all-fixed-income portfolio would increase the risk that he and his wife might someday outlive the purchasing power of their money – precisely because of the inflation he feared.

FUNDADVICE.COM: We have some clients who are 100 percent in equities, but the majority have 40 percent to 60 percent of their accounts in equities, with the rest in fixed-income. Is this a good range for most people?

TYLER: There is no single answer that fits everybody. But most people cannot afford to have less than 40 percent in equities, because they need some growth in order to maintain their purchasing power and stay ahead of inflation. And I don’t think most people can afford the risk of having much more than 60 percent in equities.

MARK: The range of 40 percent to 60 percent in equities seems to be right for a lot of people. It increases the chances that they will stick with it during challenging times.

ERIC: The right allocation depends on a person’s age and ability to deal with risk. Some investors have let their fears get the better of their good judgment. They look to us for the single answer to all the things they’re hearing. We just don’t have that magic answer. If we have done our jobs to get them into the right portfolios, they already have the best answer.

BELIEVE IN THE FUTURE

MARK: More and more, I’m coming to realize that the most important thing you must have to be a successful investor is faith in the future. We live in a world that is evolving and adjusting. Countries adjust and people adjust. On television and in the news, it’s the outlying events that are reported. It’s easy to forget that nobody reports on the good things going on all around us every day, the ways our world is working. It’s the catastrophes that sell, and that’s what people are going to hear about. These things are not a good basis for making investment decisions.

ERIC: Almost all the clients we talk to eventually let go of their fears and anger and learn to relax a bit. We all have beliefs about the future, but we don’t have knowledge of the future. I try to steer people away from making long-lasting decisions based on emotions, which are not good guides to successful investing. Occasionally somebody simply acts on the fear and sells everything to buy gold, commodities or whatever else they think will solve their problems. It’s unfortunate because this rarely works out the
way they are hoping.

MARK: All we can do is guide and advise, and they will either believe us or not. Many people have an awful time accepting the notion that things will be OK.

EMPTY OFFICES, VACANT MALLS

FUNDADVICE.COM: Is there another topic that comes up a lot these days?

MARK: A lot of people ask if we still recommend commercial real estate. We have been getting this question for the last two years. They see the vacant shopping centers, office buildings, the apartments and condos and the construction cranes that aren’t doing anything. They believe that this situation will get worse, that commercial real estate will be the next shoe to fall.

FUNDADVICE.COM: These things have been obvious for quite some time. Aren’t the problems with real estate already reflected in prices?

MARK: You’d have to be living in a cave to be unaware of these problems. Our portfolios include funds that invest in real estate investment trusts (REITs), and well-capitalized REITs will be buyers of distressed property, sometimes at fire-sale prices. The more everybody talks about this, the more the problems become built in to the prices.

I have faith that the real estate market will eventually turn the corner and once again there will be more demand than supply. I don’t know when that will happen. But I am pretty sure that by the time the news makes people feel good about investing in real estate, the big gains will already have happened.

The people who remain invested when things look bleak are the ones who will benefit when they suddenly look better. We saw that pattern in 2009 with the whole stock market, and I believe we’ll keep seeing it. That’s the way the market works. Our portfolios are designed to let clients take advantage of that pattern, whenever and wherever it occurs.

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