X-Raying Your Asset Allocation

Having been urged to ensure that the assets in your portfolio are allocated and broadly diversified in accordance with your financial goals, your investment horizon and your risk tolerance level, you have made all the necessary adjustments. Before you relax in the aura of your accomplishment, however, you may want to check your holdings in detail, just to be doubly sure you actually own what you think you own.

You can do this by putting your holdings through an X-ray. Just as your dentist can scan an X-ray and spot potential problems, an X-ray of your portfolio allows you to look under the covers. You'll gain a better understanding of what you own and can make adjustments, if necessary, on the basis of what's actually there rather than making assumptions because of general names and descriptions.

Individual mutual funds, for example, have been known to gradually stray away from their initial missions - so much so in some cases that the name of the fund may no longer be a true guide to its character. Your mid-cap fund, you could be surprised to learn, perhaps holds far more small-cap or large-cap stocks than you had imagined.

In addition, an X-ray can tell you what sectors you're exposed to, the regions of the world in which you're invested and the stock styles that characterize your portfolio - that is, how it stacks up as to its large-cap, mid-cap and small-cap holdings, as well as whether they are by nature growth, blend or value holdings.

Portfolio Character

Putting your portfolio under an X-ray can give you a thorough understanding of its various components. You can then zero in on its strengths and weaknesses and make assessments likely to be far more accurate than if you merely acted on the strength of general names or labels.

What are the real percentages of cash, U.S. stocks and bonds, foreign stocks and bonds, alternative investments, and real estate contained within your portfolio? Only with a comprehensive understanding of those true ratios can you compare your intended asset allocation with what your portfolio actually contains.

With your portfolio dissected, you can better understand how the various elements relate to and affect one another. You may discover that your portfolio is far more focused on growth than you had intended, because, say, your particular mutual funds – other than the clearly growth-focused ones – happen to also contain large growth elements you hadn’t considered. A quick glance may not show you that anything is out of line with your intentions – a detailed look under the hood may reveal otherwise.

As you look at the details of your portfolio, match up your intended allocation to the actual components revealed. Do your foreign holdings line up with your expectations? Is your small-cap exposure uncomfortably larger than you had thought?

As you check over the nuts and bolts of your portfolio, you’ll be deciding whether you’re comfortable with how its components are put together.

Spur to Action

It can be fascinating to see a detailed scan of your portfolio (or, similarly, of specific mutual fund holdings). Savvy investors use an X-ray as a guide to possible action. After comparing the details of what you learn with your expectations from your portfolio – or perhaps your 401(k) – you can work to bring it into the balance you had originally determined. When you do, you’ll be acting on the strength of basic facts rather than the sometimes erroneous impressions that linger from mutual fund names.

If you would like to discuss taking a closer look at your portfolio as a way of checking up on your asset allocation, just give me a call.

Investors should carefully consider the investment objectives, risks, charges and expenses of mutual funds before investing. The prospectus contains this and other information about mutual funds. The prospectus is available from your financial advisor and should be read carefully before investing.

Investing in small-cap and mid-cap stocks generally involves greater risks, so an investment in these stocks may not be appropriate for everyone. Asset allocation does not ensure a profit or protect against a loss. Investing involves risk and investors may incur a profit or a loss.

International investing involves additional risks such as currency fluctuations, differing financial accounting standards, and possible political and economic instability. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices rise.

Let Reality Rule As You Budget For Your Retirement Years

It’s fine to imagine a carefree retirement with unlimited travel, gourmet meals and golf at fine courses at ideal morning tee times – but as you approach the date when you plan to step away from the office, consider taking a deep breath as you stare at reality. Surprises can be wonderful, but you probably don’t want an unpleasant one when you open the door on your post-working years.

Even if your financial resources appear capable of supporting your imagined ideal retirement lifestyle, it’s a good idea to do the math, just to be certain it rests on a firm financial foundation. If your imaginings turn out to be unrealistic, you may want to consider scaling back some of your ambitions, but you won’t know your real status until you run the numbers.

Firmly Rooted

Retirement expenses can be figured in two categories, your needs (your list of essential expenses) and your wants (your list of non-essential or discretionary items - things you would very much like to do in retirement, but could, if necessary, scale back).

Essential expenses include the absolutes - your mortgage or housing costs, applicable property insurance and taxes, car payments, car insurance, fuel, repairs and maintenance, utility expenses for telephone, water, sewer, natural gas and electric, healthcare or Medicare insurance premiums (plus any others you might have, such as life insurance or long-term care), food, clothing, and estimated state and federal income taxes. The only maneuvering room you're likely to have on this list falls in the food and clothing categories. The rest typically are inflexible expenses that must be paid regularly and in full.

The discretionary list is usually shorter. On it, realistically project your expenses for travel, entertainment and dining out, and add in possible costs for hobbies, education, club memberships and charitable contributions, and any planned gifts to relatives or friends. This is a soft list, one that can be prioritized or even cut back if you find your retirement income isn't quite up to matching your expectations.

Calculate your total wants and needs on an annual basis if you prefer, but divide by 12 to give yourself a more immediate picture of your monthly income needs. Your income will come from Social Security, pension payments and your assets in general - but those are on another list.

Converting to Roth IRA in 2010 Offers Opportunity
To Split Tax Obligation Over Next Two Years*

Since late last year you have probably seen headlines proclaiming 2010 as the year the income limits are removed for those who wish to convert their traditional IRAs to Roth versions. Whether those limits were meaningful to you or not, this could be a good time to convert if you believe you would benefit – and that means performing some realistic calculations.

Essentially, Roth’s appeal is two-fold: (1) qualified withdrawals – after the account has been in existence five years and you are at least 59½ – are free of federal income tax, and (2) there are no required minimum withdrawals. In contrast, after you reach age 70½ you must take annual withdrawals from your traditional IRAs, and you’ll pay your ordinary income tax rate on those withdrawals.

That primary difference comes about because of the manner in which the two types are funded. Your tax break with traditional IRAs is on the front end – they are generally funded with pre-tax income – with taxes assessed on withdrawal. Roth IRAs are funded with after-tax income, but, as noted, qualified withdrawals are free of federal income tax. The funds inside both types of retirement accounts grow tax-free over the years.

One factor drawing investors toward converting in 2010 is the provision, for this year only, that the income tax obligation created by the conversion can be spread equally over the 2011 and 2012 tax bills, a benefit only if your tax doesn’t rise during those years. Of course, the tax can be paid in its entirety with your 2010 return, if you prefer.

Creating Tax Liability

Because income limits have been removed, conversions reportedly are up markedly this year. Nevertheless, the resulting tax bill and a host of other considerations make converting unattractive to many investors. Keep in mind, what may suit some very well indeed may not be at all advantageous to others.

Here are some of the major factors to consider:

• If you convert, you’ll owe income taxes on the amount converted – because you are withdrawing those funds from your traditional IRA. Do you have the funds to pay that tax obligation easily, without dipping into IRA money or your emergency cash?
• Are you nearing retirement? While this scenario won’t apply to everyone, there’s a chance that if you’re in your late 50s, there simply won’t be enough time for the tax-free growth of the Roth to make up for the taxes paid on conversion.
• Many interested in converting cite the likelihood of higher tax rates in the future – so converting now seems to make sense. That may apply if your income in retirement keeps you in the same bracket you now occupy, but consider that most retirees’ incomes fall, so they occupy lower brackets than during their working years.
• If you’re not already in the highest tax bracket, will converting bump you up into a higher one? Can you ameliorate that situation by splitting up your conversions over a number of years, taking care that conversion amounts don’t kick you into a higher bracket?

Deciding to Proceed

If you believe you’ll be in the same or higher tax bracket when you need the money during retirement, if you can pay the conversion tax obligation from non-IRA sources, and if you have a suitably lengthy investment time horizon, you may be a good candidate for conversion.

You may decide to convert for estate-planning purposes, especially if you have a large IRA balance unlikely to be drawn down during your retirement. You could find satisfaction in the idea of leaving a tax-free Roth to your heirs.

Whether to convert is often a complex issue, and every conversion situation should be evaluated on its own merits. If you would like to explore the idea further, just give me a call.

*The option to spread the federal income taxes over two years applies to 2010 only. Conversions in subsequent years are included in income during the tax year in which the conversion is completed. Investors should consult a tax professional about their specific situations before deciding to do a conversion.

Financial Planning:
FDIC Makes $250,000 Deposit Insurance a Permanent Fixture

The Federal Deposit Insurance Corporation (FDIC) had for years capped the insured limit on bank deposits – savings, checking, certificates of deposit, money market accounts – at $100,000. After the collapse of Lehman Brothers in 2008, when the entire banking system seemed to be teetering, the FDIC temporarily raised that limit to $250,000 in an effort to stem financial worries among the general public.

That temporary increase was originally set to expire on December 31, 2010, but in May 2009 the higher limit was extended through December 31, 2013. In July, a provision of the financial reform legislation made the $250,000 limit permanent. The insurance applies per depositor, per insured bank, for each account ownership category.

Depositors who own certificates of deposit valued above $100,000 will no longer have to worry about the reappearance of the earlier limit as the CDs mature and grow in value – as long as the total doesn’t exceed $250,000.

As of mid-July, the FDIC was insuring deposits at 7,932 U.S. banks and savings associations. The agency, funded by fees on its member institutions, likes to point out that no one has lost so much as $1 of insured deposits since the agency was created in the 1930s. Visit fdic.gov for more information.