Expert: Paul Henneman - 5/4/2004

Question
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Followup To
Question -
I am self-employed in an industry that is in decline.  In fact, revenues are down by 50 percent from 2000.  During the boom years of the 1990s I saved, and currently have $325,000 in cash.  I can still make a go of my business, but am not able to save at the same rate as before.

I am 50 years old, rent, have no children, and no debt, and still love doing the work in my business, but I would like to hear your ideas about how I should be invested.  Should I have mostly stocks in my portfolio, or should I be loading up on income securities, since I may start to need a portion of the income if the industry declines any further.  I don't like IRAs, as I do not like being pegged, and having my behavior manipulated by a paternalistic big government, but if you must comment on this subject, feel free to do so.

Thanks for your advice.
Answer -
Thank you for your question Pete!
It is good to hear that you have no debt. We can jump right to how you could be invested. So many folks love the idea of investing, but when asked they admit they have large credit card debt, car payments, mortgage payments, lots of payments. My first advice is always to pay off the high interest debt.
But you sound like you are already there.
Actually my first suggestion would be to consider a Roth IRA. The reason is the significant tax benefit. This is huge. You cannot contribute a great amount to a roth IRA, but take full advantage of what you can do. You are right about having your behaviour dictated by big government. But this is a freebie, so take it! The only drawback is that you lose the tax advantages if you withdraw before 60. So invest only what you know you won't touch until after that.
The rest of your investments should be roughly divided among very safe investments, mid risk, and higher risk.
Safe: Bonds. Very low yield, but better than simply sitting in a savings account. And very safe if done properly. Or money market account, even easier. I suggest www.NetBank.com as the highest yield money market account I have seen, and FDIC Insured up to $100,000 in case the bank fails. I can't imagine this happening, but you never know about the future, so good to have the insurance. YOu can withdraw from a money market account up to four times a month with checks or bank card with no penalty, so it is a good place to park 'emergency funds' also, and still earn about 2% interest.
Mid risk: Mutual funds. I suggest owning several that concentrate on different sectors rather than just one. Some examples of specialization: real estate, technology, finance, utilities. On average you could expect 10 to 14% average yearly returns on your mutual fund portfolio. Some years will be much better, other years you may lose money. But over time you should average about that, and your funds will grow.
High risk: Stocks. A tough thing to invest in. But if done properly, can offer more than 20% annual return to your investments. This is signficant, and worth the risk. You can manage this risk further by only investing a portion of your portfolio in stocks, as much as you are comfortable. This amount can always go up in the future as you become better at it. Start researching, subscribe to some periodicalls such as Investors Business Daily, or the FInancial Times. Websites worth looking at are www.morningstar.com, www.motleyfool.com, and www.cbsmarketwatch.com
It is worth making investments your hobby. If this sounds like too much, you could have your investments managed for you. But, your returns will likely be lower, and you will have to pay substantial sums for the management service.
A good distribution would be 50% of your investment in the money market, 35% in mutual funds, and 15% in stocks. This is fairly conservative, and you can shift more from the money market to stocks as you gain experience. Or if not comfortable, scale down in stocks as needed.
Every investor is different, don't be afraid to chart out your own path and ideas. Some great books to get started with:
"Investing for Dummies" Great introduction to a variety of investment types, including the onces I mention. This should give you a great foundation to determine what you find most attractive and do further research in those areas.
"Barron's Dictionary of Finance and Investment Terms" Great source to look up things you don't understand, you will get alot of use out of this book if you do go down a path of managing your own investments.
I hope this helps! Please do not hesitate to follow up with me if I can be of any additional service,

Sincerely,
Paul Henneman
President
ValuEngine, Inc.
www.ValuEngine.com

Thank you for your detailed and helpful answer.  I will look into the Roth IRA, however, given my predicament with my industry in such decline, I might not be able to wait until I am elderly before I will need to switch to high yielding instruments.  I will be especially interested to see if there is a penalty for early withdrawal from a Roth.

I would like your opinion on another subject that has been bothering me.  In an ideal world, one should be able to easily switch back and forth between stock mutual funds, and high-yielding tax-free muni funds, such as Nuveen (my favorite).  I like the idea of buying mutual funds when the market is in decline, and getting out to put the proceeds into tax-free muni funds when the market is high and volatile, and when current thinking is that the market is too high.  But when selling, there is the pesky problem of paying a capital gains tax, which hampers investment mobility.  Ought not there be a tax rule that says that if you sell and put money immediately into another investment, you should be exempt from taxation?  I understand that you are probably not a tax advisor, but I would still like to hear your comments on this.  I would like to know of a way to avoid paying taxes on merely a shifting of portfolio.

Thanks again for your advice.

Pete DeCamp


Answer
Pete,
  Thank you for the follow up!
  It is true that I am not a tax expert, so my suggestions and advice here should definitely be checked up on for accuracy.
  I believe that what you suggest is actually the case. If a stock or investment is held for a long enough period of time, and then shifted and reinvested, I believe that you do not have to pay capital gains. However, if the investment is held for a short period of time, such as a month, the capital gains tax applies no matter what.
  This has a huge significance for what you are trying to do and should be checked up on. Once the time period is known where you can change investments and not pay the capital gains, it should be carefully implemented into your strategy.
  A much more productive, but slightly more difficult, strategy to be invested in during market decline is shorting stocks. The problem with mutual funds is that in market decline they can also lose alot of money. Many mutual fund investors lost 30 or 40 percent of their value during 2001/2002.  Shorting stocks is essentially hedging for the stock declining in price. A strictly short portfolio is not advisable, but a portfolio that is balanced with standard long holdings and short holdings can not only protect you against a declining market, but earn strong returns at such times.
  As an example of this type of portfolio, I encourage you to look at my company's website, www.ValuEngine.com   No need to sign up for anything, I'm not an expert here to sell any service. But click on the 'Benchmark Portfolio' link to see 12 portfolio strategies we are tracking. Six are 'market neutral approaches' with short sides to the portfolio. You can read how each strategy selects stocks, and see performance charts for Jan. 2000 through Jan. 2004. Something to think about.
  I hope this helps! Please do not hesitate to follow up for anything additional, I am at your service.

Sincerely,
Paul Henneman
President
ValuEngine, Inc.
www.ValuEngine.com