What You Can Do About The Economy

You’re a smart bunch of people. I’ve known that ever since I first met you. You’re also energetic and resourceful – not accustomed to just sitting still and letting the world have its way with you. I realize that there is some frustration on your part (probably a lot of frustration) about this current economic crisis that’s going on. And to top it off, so far all I’ve told you to do is to wait it out – don’t panic – stay the course.

What I failed to mention in my previous letters to you, my friends, is that there are several common sense things that you can do right now. I’m telling you this because I recognize and appreciate your energy, your resourcefulness, and your willingness to take the hard truths of life, and apply them in a fashion that has no choice but to succeed.

Throughout this past couple of months I’ve had many folks talk to me about how worried they are – worried that we’re on the verge of another depression like we had in the 1930’s. Folks, I understand your concerns, but really – how many of you are considering pulling up stakes and walking away from your homes, to take to the road in the hopes of finding work, any work – like people did during the depression? And this went on for years… We’ve not felt any real pain like that – why, we’re just now trading in our Hummers and Navigators for something a little more economical! No, this is nothing like that at all. But the resolution is very similar, although it’s one of the hard truths that I mentioned before.

The hard truth is this: nothing is going to fix the American and world economies until we (you, me, your families, friends, and neighbors) learn to tighten our belts in a crisis, work a little harder, maybe work a little longer, and most importantly get back in that old habit of spending less than we earn (maybe a LOT less), possibly by settling for homes and autos that more realistically reflect what our finances will support. Because in the end what you save has a much greater impact on your future way of life than the returns you get in the market – good, bad, or horrendous.

This saving I’m recommending will help you to recover your losses. And here’s another hard truth that you may not want to hear: because of the market losses we’ve seen this year, you may have to work an extra year or two before retirement, or perhaps work part-time, or tighten your belt a little more than you expected to. Most likely it will be a combination of the three… but doing all of these things will put you in a much better position when the market does finally come back – even better than before!

All that we need to do (and by “we” I mean all Americans), is save a little more, work a little harder, and work a little longer. Eventually our government will also ask us to pay more taxes, especially to resolve the enormous debt we’ve built up. If our government doesn’t do this, we’re only continuing the transference of this debt forward to the future generations – and somebody is going to have to deal with it. Let’s you and I start doing something about it now.

While we’re at it, we need to put a lot of consideration into our present social programs. For example, does it really make sense for everyone to be covered by Social Security and Medicare? I think we’ve made a lot of promises that we can’t in any way afford to keep, and if we don’t face the hard truth soon, it’s all going to blow up in our faces.

The way you impact this (beyond your savings habits) is to take part in the process and get involved in making sure our government makes the hard choices. Write your congressmen and women. Call your state representatives. Take action – we have to act and act soon!

Another action you can take right now in the light of these difficult financial times is to rebalance your holdings – especially if they’re taxable accounts. If you’ve experienced losses in your taxable accounts (and let’s face it, who hasn’t?), the next six weeks are critical in terms of tax loss harvesting. For those of you whose accounts I’m managing that can benefit from this strategy, I will be in touch with you shortly to work out a plan for taking part in this strategy.

What we’ll do is sell your heavy loss positions before the end of the year and place those funds into something very safe, like municipal bonds, for the IRS-required 30 days (to avoid wash sale rules). Then, along in January we’ll take a look at your overall allocation in all of your accounts and reallocate the funds from the bond holdings into a more balanced portfolio.

You will then have a capital loss on your record that you can use to offset capital gains you may have earned this year, plus up to $3,000 of ordinary income. Any unused losses are carried over and used to offset capital gains and income (in $3,000 per year increments) indefinitely until it’s all used up. It’s a one-time activity that we must take advantage of now, before the market does pick back up. It’s a small amount of silver lining in all the dark clouds we’ve been seeing lately.

For those of you that have taxable accounts that I’m not managing, please let me know if I can help you with the process. It’s fairly straightforward, but you don’t want to make mistakes as you do this – the IRS doesn’t forgive (and they certainly don’t forget, either).

So there you have it, that’s my message. You probably already knew it, but as I said, I felt like I was doing you a disservice by not giving you more direction than to just stay the course. Feel free to pass this message along – in fact, that’s yet another thing you can do: if you agree with even a small part of this message, make an effort to relay the message to others. If, by some wild circumstance, we could get this message and the sentiment out to enough other people like you and me, think about the positive impact we’d have… and we’re just the ones to do it. It’s in our heritage.

SOSEPP - Fixed Annuitization method

When calculating your Series of Substantially Equal Periodic Payments (SOSEPP), provided for under §72(t)(2)(A)(iv) of the Internal Revenue Code, one of your choices is the Fixed Annuitization method.

Calculating your annual payment under this method requires you to have the balance of your IRA account and an annuity factor, which is found in Appendix B of Rev. Ruling 2002-62 using the age you have reached (or will reach) for that year, coupled with a rate of interest of your choice that is not more than 120% of the federal mid-term rate published by regularly the IRS in an Internal Revenue Bulletin (IRB).

Once you've calculated your annual payment under the Fixed Annuitization method, your future payments will be exactly the same until the SOSEPP is no longer in effect. There is a one-time opportunity to change to the Required Minimum Distribution method, described here.

SOSEPP - Fixed Amortization Method

When calculating your Series of Substantially Equal Periodic Payments (SOSEPP), provided for under §72(t)(2)(A)(iv) of the Internal Revenue Code, one of your choices is the Fixed Amorization method.

Calculating your annual payment under this method requires you to have the balance of your IRA account, from which you then create an amortization schedule over a specified number of years equal to your life expectancy factor from either the Single Life Expectancy table, the Uniform Lifetime table, or the Joint Life and Last Survivor Expectancy table, using the age(s) you have reached (or will reach) for that year, coupled with a rate of interest of your choice that is not more than 120% of the federal mid-term rate published by regularly the IRS in an Internal Revenue Bulletin (IRB).

Once you've calculated your annual payment under the Fixed Amortization method, your future payments will be exactly the same until the SOSEPP is no longer in effect. There is a one-time opportunity to change to the Required Minimum Distribution method, described here.

SOSEPP - RMD Method

The Required Minimum Distribution method for calculating your Series of Substantially Equal Periodic Payments (under §72(t)(2)(A)(iv)) calculates the specific amount that you must withdraw from your IRA (or other retirement plan) each year, based upon your account balance at the end of the previous year, divided by the life expectency factor from either the Single Life Expectancy table, the Uniform Lifetime table, or the Joint Life and Last Survivor Expectancy table, using the age(s) you have reached (or will reach) for that year. This annual amount will be different each year.

Changing Your SOSEPP - Once, just once

The IRS allows you to change your Series of Substantially Equal Periodic Payments (SOSEPP) allowed under §72(t)(2)(A)(iv) - one time, and only one time. And then, you're only allowed to change your method from either the fixed annuitization method or the fixed amortization method to the Required Minimum Distribution method.

This is the only exception allowed for making a change to your SOSEPP during its enforcement period, which is the later of five years after you started the SOSEPP or when you turn age 59 1/2. The exception is documented in Rev. Ruling 2002-62, 2.03(b).

Early Withdrawal of an IRA - Series of Substantially Equal Periodic Payments

This particular section of the Internal Revenue Code - specifically §72(t)(2)(A)(iv) - is the most famous of the 72(t) provisions. This is mostly due to the fact that it seems to be the ultimate answer to the age-old question "How can I take money out of my IRA without penalty?"

While it's true that this particular code section provides a method for getting at your retirement funds without penalty (and without special circumstances like first-time home purchase or medical issues), this code section is very complicated. With this complication comes a huge potential for costly mistakes - and the IRS is notorious for NOT forgiving and forgetting!

In order to set up your Series of Substantially Equal Periodic Payments (SOSEPP), you must use one of the three methods prescribed by the IRS: Required Minimum Distribution method, Fixed Amortization method, and Fixed Annuitization method. (follow the links for more information on each method)

Once chosen, your method can not be changed under most circumstances. There is one situation that provides for a one-time change to your payments, but in general the SOSEPP can't be changed. This means that every year the SOSEPP is in effect, you must take exactly the amount in your schedule from your IRA, no more and no less. Making a change to your withdrawal schedule will result in your owing the 10% penalty retroactively on all payments received to that point, plus interest. (this is the place where the IRS does not forgive)

In addition, once you've begun your SOSEPP, you must continue that payment schedule until the later of five years or you reach age 59 1/2. Again, this is an area where the IRS doesn't forgive or give any leeway: if you take additional distributions one day before your five years or 59 1/2th birthday, the action will "bust" the SOSEPP, and you'll be liable for 10% penalty on all distributions from your IRA plus penalties. Obviously this sort of an arrangement should not be taken lightly, and you must keep excellent, flawless records on your withdrawals.

Other facts about §72(t)(2)(A)(iv):

• You can split your IRA into more than one account, and apply your SOSEPP against only one account, thereby reducing the balance against which your payout method is calculated.
• You can have more than one SOSEPP going at a time, using separate IRA accounts and different payout methods for each.
• Your periodic payment could change under the minimum distribution method, as it recalculates annually based on the account balance at the end of the prior year.

Withdrawals from an IRA - death, disability, and 59 1/2

Three of the most common ways that you can withdraw funds from your IRA without penalty are - reaching age 59 1/2, death, and disability.

When you reach age 59 1/2, you can withdraw any amount of your IRA (or other deferred account) without penalty, for any reason. The only thing you have to remember is that you must pay ordinary income tax on the amount that you withdraw. This means that, at any time during the year that exactly 6 months has passed since your 59th birthday, you are free to make withdrawals from your IRA without penalty. If you reach age 59 prior to June 30 of any given year, you can take withdrawals for the entire year. However, if you reach age 59 on July 1 or after, you will have to wait until the following year to begin taking penalty-free withdrawals from your IRA.

Upon your death at any age, your beneficiaries of your account, or your estate if you have not named a beneficiary, can take distributions from your IRA in any amount for any reason without penalty.

In addition, if you are deemed "totally and permanently disabled" you are also eligible to withdraw IRA assets for any purpose without penalty. Total and permanent disability means that you have been examined by a physician and the disability is such that you can not work, and the condition is expected to last for at least one year or result in your death.

Early Withdrawal of an IRA - 72(t) Exceptions

In our first post about early withdrawal from an IRA, we mentioned that there were several exceptions in the Internal Revenue Code that allow an early withdrawal from your IRA or 401(k) without the 10% penalty being imposed. The section of the IRC that deals with quite a few of these exceptions is called Section 72(t) (referred to as §72(t) for short), and there are several subsections in this piece of the Code. Each subsection, listed below, has specific circumstances that must be met in order to provide exception to the 10% penalty. Clicking on the link for each subsection will provide you with additional details about that exception.

§72(t)(2)(A)(i) - age 59 1/2.

§72(t)(2)(A)(ii) - death at any age.

§72(t)(2)(A)(iii) - disability at any age.

§72(t)(2)(A)(iv) - series of substantially equal periodic payments (SOSEPP).

§72(t)(2)(A)(v) - separation from service on or after age 55 (401(k) only).

§72(t)(2)(A)(vi) - 404(k) dividends.

§72(t)(2)(A)(vii) - levy on a qualified plan

§72(t)(2)(B) - medical expenses.

§72(t)(2)(C) - qualified domestic relations order (QDRO) - upon a divorce settlement

§72(t)(2)(D) - health insurance premiums.

§72(t)(2)(E) - higher education expenses.

§72(t)(2)(F) - first time home purchase

In another post we'll go into the details of §72(t)(4), which describes the penalties and circumstances surrounding making changes to the SOSEPP (described in §72(t)(2)(A)(iv)), which can be quite severe, and which can take up quite a bit of time to discuss. For now, the sections above should suffice to keep us busy for a while.

Early Withdrawal of an IRA - Medical

As we covered in a previous post, there are several ways to get at your IRA funds before age 59 1/2 without having to pay the 10% penalty. In this second post in our series about Early Withdrawals, we'll cover the Medical purposes which allow this penalty-free distribution.

There are three different Medical reasons that can be used for an early withdrawal: high unreimbursed medical expenses, paying the cost of medical insurance, and disability. We'll cover each of these topics separately below.

High Unreimbursed Medical Expenses
If you are faced with high medical expenses for yourself, your spouse, or a qualified dependent, you may be eligible to withdraw some funds from your IRA penalty-free to pay for those expenses. The amount that you can withdraw is limited to the actual amount of the medical expenses you paid during the calendar year, minus 7.5% of your Adjusted Gross Income (AGI - the amount on your Form 1040, line 38, or Form 1040A line 22).

You can only count medical expenses that would otherwise have been deductible as medical expenses on Schedule A of Form 1040 - but, you don't have to itemize your deductions in order to take advantage of this exception to the 10% penalty.

Medical Insurance Premiums
You may be able to take a penalty-free distribution of some IRA funds to help pay for medical insurance premiums for yourself, your spouse, and your dependents, as long as the amount you withdraw does not exceed the amount you actually paid for medical insurance premiums, and all of the following apply:

• You lost your job.

• You received unemployment compensation paid under any federal or state law for 12 consecutive weeks because you lost your job.

• You receive the distributions during either the year you received the unemployment compensation or the following year.

• You receive the distributions no later than 60 days after you have been reemployed.

There is no income limitation on this provision.

Disability
If you become disabled prior to age 59 1/2, distributions in any amount from your IRA are not subject to the 10% penalty. Your disability must be considered of a long duration (greater than one year) or expected to result in death. The disability (physical or mental) must be determined by a physician.

Keep in mind, as we mentioned previously, these avenues provide a way to withdraw funds from your IRA penalty-free, but not tax-free. You will still be liable for ordinary income tax on any distributions that you take from your deductible IRA.

Early Withdrawal of an IRA - First Time Homebuyer

Normally, when you've put money into an IRA (or 401(k), or other deferred compensation arrangement), you are allowed to begin taking withdrawals once you've reached age 59 1/2. But sometimes you'd like to take your money out earlier... and you've probably already discovered that there is a 10% penalty for taking funds out of your IRA early, right? So - is there a way to avoid that penalty?

Yes - there are several ways, as a matter of fact. There are several sections of the Internal Revenue Code that deal with these early distributions - including 72(t) (which we'll cover in depth in another post), first time home purchase, high medical expenses (including medical insurance), disability, and others. We'll explain the first time home purchase in this post, and cover the remainder of the exceptions in other posts.

First Time Home Purchase
If you are buying, building, or re-building your first home (defined later), you are allowed to take a distribution of up to $10,000 (or $20,000 for a married couple) from your IRA to fund a portion of your costs, without paying the 10% penalty. There are a few restrictions, though - here is the official wording from the IRS:

1. It must be used to pay qualified acquisition costs (defined later) before the close of the 120th day after the day you received it.

2. It must be used to pay qualified acquisition costs for the main home of a first-time homebuyer (defined later) who is any of the following.

   1. Yourself.

   2. Your spouse.

   3. Your or your spouse's child.

   4. Your or your spouse's grandchild.

   5. Your or your spouse's parent or other ancestor.

3. When added to all your prior qualified first-time homebuyer distributions, if any, total qualifying distributions cannot be more than $10,000.

If both you and your spouse are first-time homebuyers (defined later), each of you can receive distributions up to $10,000 for a first home without having to pay the 10% additional tax.

Qualified acquisition costs. Qualified acquisition costs include the following items.

• Costs of buying, building, or rebuilding a home.

• Any usual or reasonable settlement, financing, or other closing costs.

First-time homebuyer. Generally, you are a first-time homebuyer if you had no present interest in a main home during the 2-year period ending on the date of acquisition of the home which the distribution is being used to buy, build, or rebuild. If you are married, your spouse must also meet this no-ownership requirement.

Date of acquisition. The date of acquisition is the date that:

• You enter into a binding contract to buy the main home for which the distribution is being used, or

• The building or rebuilding of the main home for which the distribution is being used begins.

The keys here are to make sure that you qualify as a first-time homebuyer (by the IRS' definition above), that you use the funds in time (before 120 days has passed), and that you haven't taken this option previously. For many folks this can be very helpful in funding the purchase of a home.

Another important point here is that you need to understand that although you do not have to pay the 10% penalty on the distribution, you WILL be required to pay ordinary income tax on any money taken from your IRA. This can be a surprise to some folks who weren't expecting it.

If you'd like to learn more about this and other options with your IRA, you can check out IRS Publication 590.

Net Unrealized Appreciation

This often-misunderstood section of the IRS code can be quite a benefit - if it happens to fit your situation. Net Unrealized Appreciation (NUA) refers to the increase in value of your company's stock held within your 401(k), either due to a company match or your own investment in the company stock within the 401(k). Other company-sponsored deferred accounts can apply here as well, but the primary type of account is the 401(k), so we'll refer to all company-sponsored tax-deferred accounts as 401(k)'s for the purpose of this discussion.

In order to take advantage of the NUA provision, first of all you must hold your company's stock in your 401(k), and you must be in a position to roll over the account. That is, you must have separated from service, by leaving employment (voluntarily or involuntarily), or the 401(k) plan is being terminated.

As you consider the rollover of your funds, if the company stock has increased in value, you have unrealized appreciation, that is, value that has not yet been realized due to a sale of the stock. The IRS allows for this appreciation to be treated as a capital gain, which can result in much lower tax rates on the gain.

In order to take advantage of this treatment, the 401(k) account must be rolled over in a one-time transaction, but there are a few things that you must do differently from other rollovers: The company stock will be rolled over into a taxable (non-IRA) account, while everything else will be rolled over into a traditional IRA.

When you roll over the company stock, this will be considered a distribution, so you must be in a position to either exclude the penalty on an early distribution (more on this in subsequent posts) or be prepared to pay a penalty plus the tax on the basis (or cost) of the stock. Your employer will have maintained records on your original cost of the stock.

As an example, let's say you have participated in your company's 401(k) plan for several years and are ready to retire. Part of the 401(k) funds have been invested over the years in your company's stock, which has cost you a total of $10,000 through the years. Your company has done well, and now that stock is worth $150,000 in the market. If you rolled over this stock into an IRA, you would pay ordinary income tax on that growth of $140,000 - at whatever is your current marginal income tax rate (for example, let's use 25%). Instead of going that route, you decide to use the NUA provision in the tax law to your advantage.

So, you set up a new IRA and a taxable account at the brokerage of your choice, and direct the 401(k) administrator to roll over your company stock to the taxable account, and all other funds to the IRA. When you roll over the company stock into the taxable account, you will be taxed (at ordinary income tax rates) on the basis of the stock - which, from our example, was $10,000. Now, not only will the growth of the stock ($140,000) have a tax rate of 15% (or less) for capital gains, you also do not have to take required minimum distributions (RMD) from those funds. You can leave the company stock in that taxable account forever if you wish, and hand it over to your heirs (who will receive a step-up in value to the current value of the stock at your passing).

Here's the math: you pay tax at our example rate of 25% on the $10,000 basis of the stock, or $2,500. Then, as you sell some of the stock, the total amount of capital gains tax would be 15% (at today's rates) of $140,000 (just the growth!) or $21,000. Compare that to the non-NUA treatment, where you might be taxed with ordinary income tax rates on the entire $150,000 stock value over time, for a total of $37,500! In this example, we've saved a total of $14,000 in taxes! Wow...

Now, NUA treatment doesn't work for all situations. For example, if your company stock has only grown minimally in value, or has gone down in value, there is little or no benefit to utilizing the NUA option. Also, if the basis of the stock is fairly high relative to the growth, it might make sense to only apply NUA treatment to a portion of your company stock.

The View From Here

Happy October to you all! I know the past several weeks have been somewhat harrowing in the financial world, but goodness, hasn't the Fall weather been fantastic so far? As unusual as our weather has been (here in Central Illinois) all year, the Autumn has just been beautiful, with sun-drenched "coolish" days, crisp evenings, and very little rain - which our local farmers have really been taking advantage of.

I've been hearing about some very good soybean and corn crop numbers, so the view from here is that it has been a pretty good year in the agricultural community. Add to that the fact that gasoline is now selling for less than $3 a gallon again, plus the stock market is back to showing signs of an upward push (we'll get to that later), things are looking pretty good, I'd say.

My point is, even as dire as things seemed from the news reports lately, there are plenty of things to be thankful for. In this month's newsletter, I'll be detailing some of the very good reasons we have to be optimistic about the financial outlooks as well. Bear in mind, you don't see the screaming headlines when things start to look good - those kinds of stories are reserved for doom and gloom - so to balance out what you hear and read, have a look at what my point of view is on the matter.

An Update On The Financial World

What a month it's been so far! I've heard from several of you, and I'm surprised I haven't received more calls. It is certainly understandable that the recent news and financial activities have you quite concerned.

This is the ugly side of our system of capitalism - where we have loosely regulated components (investment banks aren't as tightly regulated as commercial banks, obviously). Over the past few years, many companies have taken advantage of relaxed standards to make a lot, make that a boatload, of money. For example, ten years ago, no one would have thought you could have no money down, no assets, no job, and still buy a house. And, there is little doubt that many consumers were willing participants in this ruse - the blame goes to both sides. But the financial institutions should have been held to a higher standard - after all, the leaders of those organizations have been walking away with millions in salaries and bonuses, leaving the homeowners and shareholders (and uninvolved taxpayers!) to clean up the mess. While that may sound like I'm calling for additional governmental intervention, it seems that some preventative intervention would have been preferable to the "after the fact" $700+ billion intervention we've been forced to employ.

So, how we arrived at this point, and how, perhaps we might prevent it in the future is frankly, an extremely complicated issue that will be debated for decades, I'm sure. What's most important in my opinion at this stage, is for we citizen-investors to review the landscape and make good choices about what to do next, given the environment that has presented itself.

Let's start by reviewing the facts about our current situation, and what those facts mean going forward...

The Credit Markets Are In A Crisis In order for our large companies to operate effectively, nearly all of them operate within the Credit Market, borrowing cash on very limited terms (usually less than 9 months). These loans are called Commercial Paper, and Commercial Paper has traditionally been the investment of choice for money market funds, since these loans are very liquid and quite secure - meaning they can be turned into cash quite quickly. When the overall marketplace became concerned over the validity of corporate balance sheets and therefore the corporations' ability to meet these obligations, people began pulling their money out of the money market funds. When money leaves money market funds in large amounts, the fund must redeem their Commercial Paper - and when they're not buying new Commercial Paper, the corporations who depend on those loans are caught in a bind without operating cash. So when you hear talk about the "rescue" or "bailout", this is part of the reason why - corporate America is having a hard time paying its day-to-day bills without having to make dramatic moves (like selling parts of the business to raise cash, as insurer AIG is doing). The good news is that, although this is a very real problem, it is temporary, as the markets in our capitalism system have a tendency to work out kinks like this. How long will it take? Probably less than a year, but it may take longer. What are the impacts for you? Likely slightly better rates for money market funds, but also likely stiffer requirements from banks for longer-term loans like mortgages.

Investment Banks Are Broken Some of the largest investment banks (Lehman, Bear Stearns, Merrill, etc.) were heavily involved in the process of handling the Collateralized Mortgage Obligations (CMOs) that became the central derivative of the subprime mortgage crisis. These CMOs are packages of hundreds of mortgages, used as investments by all kinds of funds, investors, and companies. The problem is that 1) the underlying loans were being made on very risky terms, such as zero-down on inflated valuations of homes; and 2) the ratings agencies (Standard and Poors and Moody's among others) were not being realistic about the quality of the underlying investments. So, in other words, these CMOs were being touted as "safe" investments, when in fact they were extremely risky. Add to that set of circumstances the fact that many of these investment banks were leveraging (borrowing more money) to own the CMOs, and you've got a recipe for a real crisis when the real estate market took a dive and homeowners began to default on their mortgages, since they now held a mortgage for more than their home was worth. The good news here is that, with the "meltdown" that occurred in the debt market, new regulation and much tighter restrictions will keep this from happening again, at least as long as memory serves us. Plus, the "rescue" provides a way for some of the folks directly impacted by this (those with overblown mortgages) to gain some traction on their financial situation without losing their homes. In the meantime, even though the rescue package was characterized as a "bailout" - we taxpayers will not foot the complete bill. The remaining banks (those not up to their ears in the problem to begin with) will be purchasing the mortgage packages under much more stringent terms, effectively paying back a portion (but probably not all) of the "bailout" money, which is good for the Treasury (and we taxpayers) in the long run.

Diversification Doesn't Remove ALL Risk In a situation like we've seen over the past several weeks, where emotion and greed are ruling the day and we witness a worldwide financial meltdown, there is no safe harbor. In other words, if all investments are falling as we saw recently, just face it, unless you're only invested in CDs, your account is going to reduce in value. The good news is that this is only a temporary situation. Historically, this kind of activity has lasted from three to six months. After that, those asset classes that have become the most mis-priced through the crisis typically come back much more strongly than others - but all asset classes bounce back. At these market low positions, it might make good sense to re-balance your portfolio - that is, buy low now that you can. Of course, if you have money that has been on the sidelines in cash that you were intending to have in the market, now is an excellent time to buy in. (Hint: Warren Buffett is doing just that!)

The Short Term Market Is Driven By Fear and Greed After we saw the monumental drop off in market values last week - what happened? Only the largest single-day point gain ever for both the S&P 500 and the DJIA. But did you see the screaming headlines about how great this was? Of course not! Good news doesn't sell newspapers or TV advertising. Unfortunately, our markets will always be driven by emotion, but the good news here is that you have me to rely on - and in those times when things are sounding awful on CNBC or whatever is your medium of choice, relax, and switch it off, knowing that I'm here to do the worrying for you... That's part of my job, so switch over the baseball playoffs or tune in the debates. Don't let the fear and greed mongers dissuade you from your appropriate long-term view of things.

The Market Outlook - Historic Perspective So, with the above context, let's have a look at our current market outlook with some perspective on what happened in the stock market in past, seemingly similar situations. For context, let's use the bear market environments of 1973-1974 and 2000-2002. These two, for those that haven't read up on them, were a couple of dillies, as bear markets go. In the 1973-1974 downturn, the S&P 500 lost 43%, and in 2000-2002, it dropped 47% (this includes dividends, the actual price drops were larger). In addition to the precipitous drops in valuation, these two bear markets lingered far longer than the average - 12 months after the 1973-1974 market had crossed the 20% drop point (making it an official bear market), the market had dropped another 27%. For the 2000-2002 market, a year after its official bear declaration, stocks had lost an additional 1.2%.

These were the only two markets over the past fifty years in which the S&P 500 was lower 12 months after reaching a 20% decline. The very good news here is that neither of these markets bears much resemblance to our present marketplace. Presently we have a rumor of inflation picking up - but nothing like what we saw in the 70's with the double-digit inflation and wheezing economy that we suffered through in that decade following the bear in 1973-1974.

The more important factor is stock valuation - when the 1973-1974 bear market began, the S&P 500 was selling for 40 times the earnings of the underlying companies, and 35 times trailing earnings when the 2000-2002 bear market began. This kind of sky-high valuation was evident for the 1929 and 1987 precipitous crashes as well. But when this present bear market began, the S&P 500 was only selling for 19 times trailing earnings - not a low level, but certainly not comparable to those of the classic "crashes".

The bear market that our present situation most closely resembles is the one that occurred in 1990, which culminated in another financial crisis - that of the collapse of thousands of savings and loans. So what happened following that crisis? From 12/31/1990 to 12/31/1991, the S&P 500 increased 26%. Sounds like a pretty good outlook, don't you think? I'm not for a second suggesting that we'll see such a runup over the next 12 months, but history has shown that just such a thing is quite possible. But also remember that history should only be used as a guide - not as the answer.

The Bottom Line So, boiled down, my recommendations are as follows:

• Hold tight to your position. There is no good reason to sell your investments at this point, no matter how shaky you are. You definitely do not want to be on the sidelines in a cash position when the market begins to pick back up. Considering only the past 28 years (1980 to present), if you were fully invested in the market the entire time, your return would have been 3018% overall - but if you'd missed the best 50 days during that time period, your aggregate return would have only been 430%. On a $10,000 beginning investment, that's a difference of over a quarter-million dollars.
• Rebalance if your account needs it. Evaluate your future plans, and if they call for a restructuring of your portfolio and/or a rebalance, now is the best time to do it. Give me a call and I'll work with you to accomplish this.
• Ignore all the "noise". Shut off CNN, give yourself a break from it all. Take a walk, or watch a baseball game or a movie. (remember, I'll do the worrying for you!)
• Pass this newsletter along to your friends, families and colleagues, if you think it might help them to cope.

That's all for this month - next month we'll get back to some more uplifting topics, like IRAs and stuff like that! Until then... take care.

Special Bulletin 9/30/2008

Greetings once again. I thought it was important to drop you a note this morning to help you work through this situation in the markets, as it can look pretty dire. I want you to know that, as I stated in this newsletter earlier this month - this situation is a fleeting thing. We will soon have the "bailout" in place, and the markets will recover. It's important to keep all of this in perspective... while the headlines shout about the largest drop ever in the stock market, bear in mind that in terms of percentage, this doesn't even come close to the largest drop. I realize it can be painful to watch - but if you're invested for the long term (which you all should be) then this short-term "noise" will have little impact on your overall plan. As we've noted before, with pessimism at its height, it won't be long before things turn around. It's always darkest just before dawn.

Take a hint from this quote:

"I have not looked at any of my holdings and don't intend to. I don't want to be tempted to jump because I think I'd be more likely to jump in the wrong direction than the right one. My advice has always been to choose a sensible diversified portfolio and stop reading the financial pages. I recommend the sports section."

That was from Richard Thaler, professor of behavioral science and economics, University of Chicago Graduate School of Business.

And as always, if you want to talk it over, please give me a call.