Are Your Investments Too Volatile?

Volatility measurements can be used to evaluate the performance of mutual funds and investment portfolios as well as individual securities. An investment is considered ‘volatile’ when it experiences significant ups and downs in price…or when the prices and returns on that particular investment vary wildly from month to month (or year to year). A far cry from the market exuberance we experienced in the early spring, we are currently on the brink of a full-blown Wall Street panic, and television pundits love to use their fancy jargon to discuss this current volatility. Here’s some insight into what the heck they’re talking about.

Standard Deviation
This figure measures how much an investment’s return varies from its mean return. The higher an investment’s standard deviation is, the more dramatic its ups and downs. For example, let’s say two stocks each return an average of 6 percent a year. However, one of those stocks might have a much higher return in some years, but lose a lot of value in others. That stock’s standard deviation from its mean would be quite high. The second stock might achieve the same average without such dramatic price swings, and would therefore have a lower standard deviation.

Beta
Another way to evaluate an investment’s volatility is to look at its beta, which compares an individual investment’s volatility to that of the market. A stock or mutual fund with a beta of 1.0 would have exactly as much market risk as its benchmark–for example, the S&P 500 stock index. A stock or mutual fund with a beta of 1.5 would involve 50 percent more market risk than the benchmark; if the benchmark went up, the individual security would be expected to go 50 percent higher. If the benchmark’s return dropped, the security’s return should be 50 percent lower. Conversely, a stock or fund with a beta of less than 1.0 would involve less market-related volatility than the overall market. If the S&P rose by 50 percent, an investment with a beta of .5 should benefit by only 25 percent. If the benchmark fell by 50 percent, the individual security with a .5 beta should experience only a 25 percent drop.

R-Squared
Beta as a measurement of volatility is useful only if the investment is being compared to an appropriate benchmark. R-squared measures how much of an investment’s volatility depends on the volatility of its benchmark. If an investment’s performance is perfectly correlated with that of the overall market, it would have an R-squared of 1.00. The lower the R-squared, the less the investment’s performance can be explained by the market’s overall performance. For example, a stock with an R-squared of .80 would mirror the performance of the S&P 500 index much more closely than a stock with an R-squared of .40, which would be much more affected by factors specific to that stock.

Alpha
In addition to risk and reward that is linked to market movements, an investment involves risk and reward that is unique to the investment itself. A stock, for example, might benefit from superior management of the company, or suffer because of a substantial delay in launching an important product. Alpha indicates how well an investor is being compensated for the level of that specific (nonmarket-related) risk. It compares an investment’s returns to the performance an investor might expect given the level of risk indicated by its beta. A positive alpha would mean that for the time period measured, the investment has done better than the return that investors could have predicted simply by multiplying its beta figure times the return of the benchmark index. A negative alpha means just the opposite: that the investment’s returns have been worse than they should have been for the level of risk taken. At the portfolio level, alpha is a way to gauge whether you benefit from active management, compared to simply investing passively in an index.

Let’s Get Technical: Measuring Overall Market Volatility
One way investors sometimes try to gauge short-term volatility in the market as a whole is to look at the Volatility Index (VIX) created by the Chicago Board Options Exchange. The VIX is calculated as a percentage figure by averaging the prices of options on the S&P 500 index. The figure, which is calculated minute-by-minute based on ongoing options trading, is used to gauge investor expectations for market volatility over the next 30 days. Though past performance is no guarantee of future results, options prices tend to rise when the markets are in turmoil and investor anxiety is high. That pushes the VIX up as well. When investors are feeling more certain about the future, options prices and the VIX tend to drop.

Balance Your Investment Choices with Asset Allocation

Chocolate cake. Pasta. Pancakes. They’re all very different, but they generally involve flour, eggs, and perhaps a liquid. Depending on how much of each ingredient you use, you can get very different outcomes. The same is true of your investments. Balancing a portfolio means combining various types of investments using a recipe that’s right for you.

Getting the Right Mix
The combination of investments you choose can be as important as your specific investments. The mix of various asset classes, such as stocks, bonds, and cash equivalents, accounts for most of the ups and downs of a portfolio’s returns.

There’s another reason to think about the mix of investments in your portfolio. Each type of investment has specific strengths and weaknesses that enable it to play a specific role in your overall investing strategy. Some investments may be chosen for their growth potential. Others may provide regular income. Still others may offer safety or simply serve as a temporary place to park your money. And some investments even try to fill more than one role. Because you probably have multiple needs and desires, you need some combination of investment types.

Balancing how much of each you should include is one of your most important tasks as an investor. That balance between growth, income, and safety is called your asset allocation. It doesn’t guarantee a profit or insure against a loss, but it does help you manage the level and type of risks you face.

Balancing Risk and Return
Ideally, you should strive for a mixture of investments that minimizes the risk you take in trying to achieve a targeted rate of return. This often means balancing more conservative investments against others that are designed to provide a higher return but that also involve more risk. For example, let’s say you want to get a 7.5% return on your money. You should keep in mind that market returns have historically averaged about 10% annually, and bonds roughly 5%. One way to try to achieve your 7.5% return would be by choosing a 50-50 mix of stocks and bonds. It might not work out perfectly that way, of course. This is only a hypothetical illustration, not a real portfolio, and there’s no guarantee that either stocks or bonds will perform as they have in the past. But at least asset allocation gives you a place to start.

Someone living on a fixed income, whose priority is having a regular stream of money coming in, will probably need a very different asset allocation than a young, well-to-do working professional whose priority is saving for a retirement that’s 30 years away. Many publications feature model investment portfolios that recommend generic asset allocations based on an investor’s age. These can help jump-start your thinking about how to divide up your investments. However, because they’re based on averages and hypothetical situations, they shouldn’t be seen as definitive. Your asset allocation is–or should be–as unique as you are. Even if two people are the same age and have similar incomes, they may have very different needs and goals. You should make sure your asset allocation is tailored to your individual circumstances.

Many Ways to Diversify
When we refer to asset allocation, we’re usually talking about overall classes: stocks, bonds, and cash or cash equivalents. However, there are others that also can be used to complement the major asset classes once you’ve got those basics covered. They include real estate and alternative investments such as hedge funds, private equity, metals, or collectibles. Because their returns don’t necessarily correlate closely with returns from major asset classes, they can provide additional diversification and balance in a portfolio.

Even within an asset class, consider how your assets are allocated. For example, if you’re investing in stocks, you could allocate a certain amount to large-cap stocks and a different percentage to stocks of smaller companies. Or you might allocate based on geography, putting some money in U.S. stocks and some in foreign companies. Bond investments might be allocated by various maturities, with some money in bonds that mature quickly and some in longer-term bonds. Or you might favor tax-free bonds over taxable ones, depending on your tax status and the type of account in which the bonds are held.

Asset Allocation Strategies
There are various approaches to calculating an asset allocation that makes the most sense for you.

The most popular approach is to look at what you’re investing for and how long you have to reach each goal. Those goals get balanced against your need for money to live on. The more secure your immediate income and the longer you have to achieve your investing goals, the more aggressively you might be able to invest for them. Your asset allocation might have a greater percentage of stocks than either bonds or cash, for example. Or you might be in the opposite situation. If you’re stretched financially and would have to tap your investments in an emergency, you’ll need to balance that fact against your longer-term goals. In addition to establishing a (very important) emergency fund, you may need to invest more conservatively than you might otherwise want to.

Some investors believe in shifting their assets among asset classes based on which types of investments they expect will do well or poorly in the near term. However, this approach, called “market timing,” is extremely difficult even for experienced investors. If you’re determined to try this, you should probably get some expert advice–and recognize that no one really knows where markets are headed.

Some people try to match market returns with an overall “core” strategy for most of their portfolio. They then put a smaller portion in very targeted investments that may behave very differently from those in the core and provide greater overall diversification. These often are asset classes that an investor thinks could benefit from more active management.

Just as you allocate your assets in an overall portfolio, you can also allocate assets for a specific goal. For example, you might have one asset allocation for retirement savings and another for college tuition bills. A retired professional with a conservative overall portfolio might still be comfortable investing more aggressively with money intended to be a grandchild’s inheritance. Someone who has taken the risk of starting a business might decide to be more conservative with his or her personal portfolio.

Things to Consider:

• Don’t forget about the impact of inflation on your savings. As time goes by, your money will probably buy less and less unless your portfolio at least keeps pace with the inflation rate. Even if you think of yourself as a conservative investor, your asset allocation should take long-term inflation into account.
• Your asset allocation should balance your financial goals with your emotional needs. If the way your money is invested keeps you awake worrying at night, you may need to rethink your investing goals and whether the strategy you’re pursuing is worth the lost sleep.
• Your tax status might affect
  your asset allocation, though your decisions shouldn’t be based solely on tax concerns.

Even if your asset allocation was right for you when you chose it, it may not be right for you now. It should change as your circumstances do and as new ways to invest are introduced. A piece of clothing you wore 10 years ago may not fit now; you just might need to update your asset allocation, too.

Dollar-Cost Averaging

We generally advise new investors relating to how often (and how much) money to invest in their retirement and educational savings accounts. At Lightship Mutual, we are staunch supporters of the “buy and hold” model of long-term investing, one of our favorite strategies is dollar-cost averaging. With this strategy, our clients are instructed to invest a small amount of money regularly, regardless of market conditions.

Quick and Easy Investing
With dollar cost averaging, you invest the same dollar amount at regular intervals (i.e. monthly, quarterly, semi-annually) over a long period time. By consistently following this strategy, you may be able to reduce the impact of market fluctuations on your investment portfolio.*

For example, let’s say that you decide to invest $300 each month towards your child’s college education. As the following illustration shows, you automatically buy more shares when prices are low and fewer shares when prices are high:

Average market price per share: $30 + $10 +$20 + $15 + $25 = $20 5 purchases Investor’s average cost per share: $1,500 total investment = $17.24 87 shares purchased

Your regular monthly investment of $300 bought more shares when the price was low and fewer shares when the price was high. The result? The average cost of the shares you purchased is less than the average market price per share over the period.

It’s [Not Always] About the Benjamins
Even though our example above uses a $300 monthly investment, dollar-cost averaging works with as little as $25 per month. The key is not necessarily how much you can afford to put away each month, but how consistently you do it. You are building positive financial habits, and dollar-cost averaging is the investing equivalent of brushing & flossing.

This hypothetical example is for illustrative purposes only and does not represent the performance of any particular investment. Actual results will vary.

*Dollar cost averaging does not guarantee a profit or protect against a loss in a declining market. Investors should consider their ability to continue investing regularly through all types of markets.

How to Handle Stock Market Volatility

Keeping your cool can be hard to do when the markets go on their roller-coaster rides of late. But it is vital to have strategies in place that prepare you both financially and psychologically to handle this inevitable market volatility.

Have a Game Plan Against Panic
Having predetermined guidelines that anticipate turbulent times can help prevent emotion from dictating your decisions. If you’re an active investor, a trading discipline can help you stick to a long-term strategy. For example, you might determine in advance that you will take profits when the market rises by a certain percentage, and buy when the market has fallen by a set percentage. Or you might take a core-and-satellite approach, combining the use of buy-and-hold principles for the bulk of your portfolio with tactical investing based on a shorter-term market outlook. You can use diversification to offset the risks of certain holdings with those of others. Diversification may not ensure a profit or guarantee against a loss, but it can help you understand and balance your risk in advance.

Consider Playing Defense
Many investors try to prepare for volatile periods by reexamining their allocation to such defensive sectors as consumer staples or utilities (though, like all stocks, those sectors involve their own risks). Dividends also can help cushion the impact of price swings.

Use Cash to Help Manage Your Mindset
Cash can be the financial equivalent of taking deep breaths to relax. It can enhance your ability to make thoughtful decisions instead of impulsive ones. If you’ve established an appropriate asset allocation, you should have enough resources on hand to prevent having to sell stocks to meet ordinary expenses or, if you’ve used leverage, a margin call.

A cash cushion coupled with a disciplined investing strategy can change your perspective on market downturns. Knowing that you’re positioned to take advantage of a market swoon by picking up bargains may increase your willingness to be patient.

Know What You Own and Why You Own It
When the market sneezes, knowing why you originally made a specific investment can help you evaluate whether those reasons still hold, regardless of what the overall market is doing. If you don’t understand why a security is in your portfolio, find out. A stock may still be a good long-term opportunity even when its price has dropped.

Remember That Tomorrow is Another Day
The market is nothing if not cyclical. Even if you wish you had sold at what turned out to be a market peak, or regret having sat out a buying opportunity, you may well get another chance at some point. Even if you’re considering changes, a volatile market is probably the worst time to turn your portfolio inside out. A well-thought-out asset allocation is still the basis of good investment planning.

Learn From Your (and Others’) Mistakes
Everyone looks good during bull markets, but smart investors emerge during the inevitable rough patches. Even the best aren’t right all of the time. If an earlier choice now seems rash, sometimes the best strategy is to take a loss, learn from the experience, and apply the lesson to future decisions.

A qualified financial professional can help prepare you and your portfolio to both weather and take advantage of the market’s ups and downs.

ETFs: Do They Belong in Your Portfolio? — PT. II

One of the reasons (Exchange Traded Funds) ETFs have gained ground with investors is because of their low annual expenses. Also, investing in an index means that trades are generally made only when the index itself changes. As a result, the trading costs required by frequent buying and selling of securities in the fund are minimized. We discussed some general characteristics of ETFs in part one of our discussion earlier this week, so let’s further examine the mysterious ETF.

What Makes an ETF So Special?
ETFs are another example of passive index investing, which means an ETF–much like an index mutual fund–doesn’t require a portfolio manager or a research staff to select securities; this greatly reduces the fund’s overhead expenses. On the other hand, you will pay a commission each time you buy or sell ETF shares (just like stocks). For you, this means that a lump-sum investment into an ETF will likely be more cost-effective than dollar-cost averaging, which involves frequent, regular investments over time.

ETFs and Taxes
ETFs can be relatively tax efficient. Because it trades so infrequently, an ETF typically distributes few capital gains during the year. In the past, there have been times when some investors found themselves paying taxes on capital gains generated by a mutual fund, even though the value of their fund may actually have dropped. Although it is possible for an ETF to have capital gains, ETFs generally can minimize the ongoing capital gains taxes you’ll pay.

Other Reasons to Invest in ETFs

• Exposure to a particular industry or sector of the market
• Because the minimum investment in an ETF is the cost of a single share, ETFs can be a low-cost way to make a diversified investment in alternative investments, a particular investing style, or geographic region.
• Loss Limits
• The ability to set a stop-loss limit on your ETF shares can help manage potential losses. A stop-loss order instructs your broker to sell your position if the shares fall to a certain price.

How to Evaluate an ETF

1) Look at the index it tracks. Understand what the index consists of and what rules it follows in selecting and weighting the securities in it.

2) Examine how long the fund and/or its underlying index have been in existence, and if possible, how both have performed in good times and bad.

3) Research the fund’s expense ratios. The more straightforward its investing strategy, the lower expenses are likely to be. An index using futures contracts is likely to have higher expenses than one that simply replicates the S&P 500.

A qualified financial professional can help you decide if (and how) ETFs might fit your long-term investing strategy.

ETFs: Do They Belong in Your Portfolio? — PT. I

Exchange-traded funds (ETFs) have become increasingly popular since they were introduced in the United States in the mid-1990s. Their tax efficiencies and relatively low investing costs have attracted investors who like the idea of combining the diversification of mutual funds with the trading flexibility of stocks. ETFs can fill a unique role in your portfolio, but you need to understand just how they work and the differences among the dizzying variety of ETFs now available.

What is an ETF?
Like a mutual fund, an exchange-traded fund pools the money of many investors and purchases a group of securities. Like index mutual funds, most ETFs are passively managed. Instead of having a portfolio manager who uses his or her judgment to select specific stocks, bonds, or other securities to buy and sell, both index mutual funds and exchange-traded funds attempt to replicate the performance of a specific index.

However, a mutual fund is priced once a day, when the fund’s net asset value is calculated after the market closes. If you buy after that, you will receive the next day’s closing price. By contrast, an ETF is priced throughout the day and can be bought on margin or sold short–in other words, it’s traded just as a stock is.

How ETFs Invest
Since their inception, most ETFs have invested in stocks or bonds, buying the shares represented in a particular index. For example, an ETF might track the Nasdaq 100, the S&P 500, or a bond index. Other ETFs invest in hard assets–for example, gold bullion. In such cases, a commodity or precious-metals ETF may buy futures contracts or quantities of bullion. With the rapid proliferation of ETFs in recent years, if there’s an index, there’s a good chance there’s an ETF that invests in it.

The New Wave of ETFs
New and unique indexes are being developed every day. As a result, ETFs that might seem similar–for example, two funds that invest in large-cap stocks–can actually be quite different. Many indexes define which securities are included based on their market capitalization–the number of shares outstanding times the price per share. However, other indexes and the ETFs that mimic them may select or weight securities within the index based on fundamental factors, such as a stock’s dividend yield.

Why is weighting important? Because it can affect the impact that individual securities have on the fund’s result. For example, an index that is weighted by market cap will be more affected by underperformance at a large-cap company than it would be by an underperforming company with a smaller market cap. That’s because the large-cap company would represent a larger share of the index. However, if the index weighted each security equally, each would have an equal impact on the index’s performance.

Pros and Cons of Exchange-Traded Funds

Pros
ETFs can be traded throughout the day as price fluctuates
ETFs can be bought on margin, sold short, or traded using stop orders and limit orders, just as stocks can
ETFs do not have to hold cash or buy and sell securities to meet redemption demands by fund investors
Annual expenses are often lower, which can be especially important for long-term investors
Because ETFs typically trade securities infrequently, they have lower annual taxable distributions than a mutual fund
Cons
Dollar-cost averaging will require paying repeated commissions and will increase investing costs
If an ETF is organized as a unit investment trust, delays in reinvesting its dividends may hamper returns
An ETF doesn’t necessarily trade at its net asset value, and bid-ask spreads may be wide for thinly traded issues or in volatile markets

More and more new indexes are being introduced, many of which cover narrow niches of the market, or use novel rules to choose securities. Many so-called rules-based ETFs are beginning to take on aspects of actively managed funds–for example, by limiting the percentage of the fund that can be devoted to a single security or industry.

But Wait…There’s More.
As indicated above, one of the reasons ETFs have gained ground with investors is because of their low annual expenses. Later this week, we’ll take a look at Part II of our ETF extravaganza and cover the advantages, trade offs, and special taxation associated with ETF investing.

How To Handle an Inherited 401(k) Plan Account

When you inherit a 401(k) plan account, the options available to you depend on a number of factors, including the terms of the 401(k) plan and your relationship to the deceased 401(k) plan participant. In general, you’ll have four options: take an immediate distribution, disclaim all or part of the assets, leave the money in the 401(k) plan (if the plan permits), or roll the funds over to an IRA.

Should You Take the Cash?
Obviously, if you need the funds immediately, taking a lump-sum distribution from the 401(k) plan may be your only viable alternative. But you’ll have to pay ordinary income tax on the distribution (certain exclusions apply; talk to your financial professional for details).

A lump sum might also be attractive if you’re entitled to a distribution of employer stock. You may be able to pay ordinary income tax on just the participant’s basis in the stock, and defer tax on the appreciation (also called “net unrealized appreciation”) until you sell the stock in the future–at capital gain rates.

What’s a Disclaimer?
When you disclaim (i.e., refuse to accept) 401(k) assets, they pass instead to the plan participant’s contingent beneficiary, or estate if there is no contingent beneficiary. In general, you must give the plan written notice of your intent to disclaim the funds within nine months after the participant’s death. But be careful not to exercise control over the funds in the meantime (for example, by choosing a distribution option or by exercising investment control), or you may lose your ability to disclaim the funds.

A disclaimer may be an attractive option if you’re sure you won’t need the funds, and the transfer to the contingent beneficiary makes good economic and estate planning sense.

The Problem With 401(k) Plans
If you’re like most beneficiaries, your goal will be to stretch payments out as long as possible, taking full advantage of the tax deferral offered by retirement plans. This means either leaving the assets in the 401(k) plan, or rolling them over to an IRA.

For most, leaving the funds in the 401(k) plan isn’t the best choice for two reasons. First, the investment alternatives available to you in a 401(k) plan are limited to the ones selected by the employer. Second, the distribution options offered by a 401(k) plan typically aren’t as flexible as those available in an IRA. In fact, many 401(k) plans require beneficiaries to take distributions shortly after the participant’s death.

Roll the Funds Over to an IRA
Unless the 401(k) plan offers a unique investment alternative, rolling the 401(k) assets over to an IRA will usually be your best choice. IRAs offer virtually limitless investment options. And when it comes time to take distributions from the plan, IRAs offer the most flexible payment provisions. But, before deciding on a rollover, make sure you understand any fees and expenses that may apply.

If you’re a surviving spouse, you’ll have to decide between rolling the funds over to your own IRA, or to an IRA that you establish in the participant’s name, with you specified as the beneficiary (this is referred to as an “inherited IRA”).

Which Should you Choose?
In most cases, spouses are better off rolling the funds over to their own IRA. A rollover is typically appropriate only if you’re younger than 59½ and you think you’ll need the funds before you reach that age. That’s because distributions from an inherited IRA aren’t subject to the 10% early distribution penalty tax. (In contrast, distributions from your own IRA before age 59½ are subject to the 10% penalty tax unless an exception applies.)

What About Non-Spouses?
If you’re not the surviving spouse, you don’t have the option of rolling the 401(k) assets over to your own IRA. But thanks to the Pension Protection Act of 2006, you may be able to make a direct rollover of the 401(k) funds to an inherited IRA. A 401(k) plan isn’t required to offer this option, so check with your plan administrator. This new rule applies to distributions you receive after 2006.

The rules governing inherited 401(k) plan accounts are complex. A financial advisor can help you sort through the alternatives, and make the decision most appropriate for your individual circumstances.

Should You Pay Off Your Mortgage Early or Invest the Extra Cash?

Home ownership is a dream that many Americans share. However, a mortgage can be an enormous burden, and paying it off asap is the first item on many consumers’ to-do list. But competing with the desire to own a home “free and clear” is a need to invest for retirement, children’s college education, and other goals. Setting aside some extra cash for these goals may mean sacrificing other opportunities. So how do you choose?

Evaluate the Opportunity Costs
Deciding between prepaying your mortgage and investing your extra cash isn’t easy, because each option has advantages and disadvantages. But you can start by weighing what you’ll gain financially by choosing one option versus the others. In economic terms, this is known as evaluating the opportunity costs.

Here’s an example. Let’s assume that you have a $300,000 balance and 20 years remaining on your 30-year mortgage, and you’re paying 6.25% interest. If you were to put an extra $400 toward your mortgage each month, you would save approximately $62,000 in interest, and pay off your loan almost 6 years early.

By making extra payments and saving all of that interest, you’ll clearly be gaining a lot of financial ground. But before you opt to prepay your mortgage, you still have to consider what you might be giving up by doing so–the opportunity to potentially profit even more from investing.

To determine if you would come out ahead if you invested your extra cash,start by looking at the after-tax rate of return you can expect from prepaying your mortgage. This is generally less than the interest rate you’re paying on your mortgage, once you take into account any tax deduction you receive for mortgage interest. Once you’ve calculated that figure, compare it to the after-tax return you could receive by investing your extra cash.

For example, the after-tax cost of a 6.25% mortgage would be approximately 4.5% if you were in the 28% tax bracket and were able to deduct mortgage interest on your federal income tax return (the after-tax cost might be even lower if you were also able to deduct mortgage interest on your state income tax return). Could you receive a higher after-tax rate of return if you invested your money instead of prepaying your mortgage?

Keep in mind that the rate of return you’ll receive is directly related to the investments you choose. Investments with the potential for higher returns may expose you to more risk, so take this into account when making your decision.

Other Points to Consider
While evaluating the opportunity cost is important, you’ll also need to weigh many other factors. The following list of questions may help you decide which option is best for you.

• What’s your mortgage interest rate? The lower the rate on your mortgage, the greater the potential to receive a better return through investing.
• Does your mortgage have a prepayment penalty? Most mortgages don’t, but check before making extra payments.
• How long do you plan to stay in your home? The main benefit of prepaying your mortgage is the amount of interest you save over the long term; if you plan to move soon, there’s less value in putting more money toward your mortgage.
• Will you have the discipline to invest your extra cash rather than spend it? If not, you might be better off making extra mortgage payments.
• Do you have an emergency account to cover unexpected expenses? It doesn’t make sense to make extra mortgage payments now if you’ll be forced to borrow money at a higher interest rate later. And keep in mind that if your financial circumstances change–if you lose your job or suffer a disability, for example–you may have more trouble borrowing against your home equity.
• How comfortable are you with debt? If you worry endlessly about it, give the emotional benefits of paying off your mortgage extra consideration.
• Are you saddled with high balances on credit cards or personal loans? If so, it’s often better to pay off those debts first. The interest rate on consumer debt isn’t tax deductible, and is often far higher than either your mortgage interest rate or the rate of return you’re likely to receive on your investments.
• Are you currently paying mortgage insurance? If you are, putting extra toward your mortgage until you’ve gained at least 20% equity in your home may make sense.
• How will prepaying your mortgage affect your overall tax situation? For example, prepaying your mortgage (thus reducing your mortgage interest) could affect your ability to itemize deductions (this is especially true in the early years of your mortgage, when you’re likely to be paying more in interest).
• Have you saved enough for retirement? If you haven’t, consider contributing the maximum allowable each year to tax-advantaged retirement accounts before prepaying your mortgage. This is especially important if you are receiving a generous employer match. For example, if you save 6% of your income, an employer match of 50% of what you contribute (i.e., 3% of your income) could potentially add thousands of extra dollars to your retirement account each year. Prepaying your mortgage may not be the savviest financial move if it means forgoing that match or shortchanging your retirement fund.
• How much time do you have before you reach retirement or until your children go off to college? The longer your time frame, the more time you have to potentially grow your money by investing. Alternatively, if paying off your mortgage before reaching a financial goal will make you feel much more secure, factor that into your decision.

The Middle Ground
If you need to invest for an important goal, but you also want the satisfaction of paying down your mortgage, there’s no reason you can’t do both. It’s as simple as allocating part of your available cash toward one goal, and putting the rest toward the other. Even small adjustments can make a difference. For example, you could potentially shave years off your mortgage by consistently making biweekly, instead of monthly, mortgage payments, or by putting any year-end bonuses or tax refunds toward your mortgage principal.

And remember, no matter what you decide now, you can always reprioritize your goals later to keep up with changes to your circumstances, market conditions, and interest rates.

Beyond 401(k)s and IRAs: Enjoy Your Life Today

You’re contributing the maximum to a 401(k) and also maxing out your Roth or traditional IRA. But, as a master spendthrift, you still have additional dollars you could save to ensure your retirement is everything you hope for. What options do you have?

Make Sure You Have a Life Today
Aggressive saving is a habit that all financially responsible people share. But don’t get carried away. Even though you’ll want a fulfilling retirement in 2050, don’t neglect your quality of life today. While you’re young, remember to also spend money on current experiences with others: fulfilling hobbies, international travels, and group outdoor adventures should be at the top of your list.

Besides, if you’re responsible enough to max out a 401k and a Roth IRA, then you probably also have a pile of cash sitting quietly in a savings account. You’ve setup an emergency fund already and are now looking for additional ways to put your dollars to work. If this is your situation, then trust us, you can afford to indulge yourself in a hot-air-balloon ride, a week in Spain, or a few days at the spa.

And after all of that, if you’ve still got some cash left over (lucky you!), then here are some other ways to set aside long-term dollars for retirement.

Are You Really Maxing Out Your 401(k) and IRA?
IRAs and 401(k)s have real advantages when it comes to saving for retirement. So, before you go any further, make sure you’re really contributing all you can.

In 2007, most individuals can contribute up to $15,500 to a 401(k) plan, and up to $4,000 to a traditional or Roth IRA. What’s more, if you file a joint tax return with your spouse, your spouse may be able to make a full IRA contribution, even if he or she has little or no taxable compensation.

Look at Deferred Annuities
If you are looking beyond 401(k)s and IRAs, one option you may be aware of is a deferred annuity. Deferred annuities are generally funded with after-tax dollars, but earnings are tax deferred, which means you don’t pay tax until you take a distribution from the annuity. There’s also no annual limit on contributions to an annuity.

The tax deferral offered by a deferred annuity is a nice feature, but it comes with some trade offs that you’ll need to weigh carefully:

• There are usually costly fees such as annual expenses, investment management fees, and insurance expenses
• A surrender charge may be imposed if you withdraw funds within a certain period of time
• A 10% federal penalty tax (in addition to any regular income tax) may apply if you withdraw funds from an annuity before age 59½
• Investment gains are taxed at ordinary income tax rates, not at lower capital gains rates

Annuities do have some unique benefits beyond tax deferral. With annuities, you can elect an annual payment amount that is guaranteed for the rest of your life (the guarantee is subject to the payment ability of the issuing institution)–this relative degree of certainty can be psychologically and financially comforting. In addition, annuities may offer some creditor protection under state law.

Taxable Investment Accounts
Your other basic option is to invest through a taxable investment account. The lower federal income tax rates that apply to long-term capital gains and qualifying dividends go a long way toward taking the bite out of holding investments outside of a tax-advantaged retirement account like a 401(k) or IRA. And, a taxable investment account offers one enormous advantage: You gain a tremendous amount of flexibility. You can choose from a virtually unlimited selection of specific investments, and there’s no federal penalty for withdrawing funds before age 59½.

Investment options worth mentioning:

• Index mutual funds and exchange-traded funds (ETFs) trade infrequently and therefore tend to have low annual taxable distributions
• Tax-free municipal bonds and municipal bond funds generate income that is free from federal and/or state income tax

Remember the Big Picture
Your investment decisions should be based on your individual goals, time frame, risk tolerance, and investment knowledge. You should evaluate every investment decision with an eye toward how the investment will fit into your overall investment portfolio, and whether it will meet your general asset allocation needs. A financial professional can be invaluable in helping you evaluate your options.

Investing Overseas BRIC by BRIC

Emerging markets have been of enormous interest to our clients in recent years, and none have created a greater stir than a group of countries collectively labeled BRIC (Brazil, Russia, India, and China).

Why All the Fuss?
The recent interest is all about the numbers. Investors have looked at development in BRIC countries, population statistics, and the global economy, and many have concluded that the long-term potential in BRIC is the next great worldwide growth story.

As a result, indexes that attempt to reflect BRIC performance have soared in the last several years. The Dow Jones BRIC 50, which includes the largest and most liquid securities of each country, rose by more than 300% between December 31, 2002, and mid-2006 (source: Dow Jones).

Several factors are driving the newfound attention to BRIC investments:

Globalization and growth–Worldwide demand for energy and other commodities, the outsourcing phenomenon, and widespread access to global capital have helped fuel the BRIC countries’ growth. India dominates service outsourcing, Brazil and Russia have vast energy and mineral resources, and China has developed into the world’s manufacturing plant. India’s economy is growing at 8.5% a year, and China’s at more than 10.5%, compared to 3.1% U.S. growth (source: 2006 CIA World Factbook).

Huge populations, future buyers–Together, the BRIC countries represent 42% of the world’s population, again according to the CIA World Factbook. That number represents enormous untapped future purchasing power. It gives BRIC countries the potential for even more rapid expansion if their economies continue to develop and the benefits reach a greater percentage of their populations.

Reduced reliance on foreign debt–Growth has helped BRIC countries pay down loans incurred during previous economic crises, though the potential for default on that debt could still present an investment risk.

Riding the Roller Coaster
Despite the recent success of these regions–or because of it–money managers are divided on how long the rise of emerging markets can continue without a significant correction. Because commodities are so important to the BRIC economies, any slowdown in worldwide growth and therefore demand could have a significant impact on investments there. Other risks exist as well. All four countries have experienced political instability, currency fluctuations, and/or economic problems. Investors who were affected won’t soon forget Russia’s 1998 economic crisis or Brazil’s bouts with rampant inflation in the late 1980s and early 1990s.

Also, economic growth rates don’t necessarily translate directly into stock market returns; until the last year or so, China’s stock market suffered serious multiyear losses.

BRIC Investing and Beyond
You have many ways to take advantage of the projected growth in these regions. One of the most popular is index mutual funds or exchange-traded funds (ETFs), which may be based on an index for an individual country or one that’s BRIC-wide. You might also want to explore beyond the BRICs. Other emerging markets might have great growth potential but might not yet have attracted as much investor attention. Diversified emerging-markets funds often have a large exposure to the BRIC countries. The number of BRIC-specific companies is relatively limited; including other emerging markets as well as the BRICs gives a fund manager an expanded universe of securities from which to select.

If you’re interested in individual stocks, some of the largest BRIC firms are listed on U.S. exchanges via American Depositary Receipts (ADRs).

The historical volatility of emerging markets means you should take a long-term view, and be prepared for the possibility of ups and downs along the way. A qualified financial professional can help you decide whether emerging markets are appropriate for your risk tolerance, time horizon, and overall portfolio, and he/she can suggest how to balance the potential risks and rewards.

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