Forecasts & Trends : Investment Strategies

The Stock Market Conundrum

Gary D. Halbert — Tue, 06 Oct 2009 19:14:00 GMT

IN THIS ISSUE:

Ball of Confusion
The Gloom-and-Doom Argument
Damn the Torpedoes, Full Speed Ahead!
Is the Market Defying Gravity?
What You Should be Doing

Introduction

The cover of the October 5, 2009 issue of Business Week magazine summed up the current dilemma for stock market investors perfectly. It had a staircase running diagonally across the page, with one figure climbing up the stairs, and the other going down the stairs. The "upstairs" view had the caption, "Why the Market Will Keep Going Up," while the downstairs view was labeled, "Why the Market is Going Nowhere."

The fact that both cases can be made in a single magazine article shows that there are good reasons for the market to go up, and equally good reasons for it to go sideways, or even down. The fact that the S&P 500 Index has risen over 50% since the March lows has both bulls and bears scratching their heads. And nobody knows what lies ahead.

There's little wonder why $3-$4 trillion of investor assets are reportedly still sitting on the sidelines in cash, even though the market's rally since the March 9th lows has been nothing short of spectacular. You would think that even hesitant investors would now be piling into the market. Some have, but much of this sideline money is staying put where it won't be subject to another round of losses, should the market rally suddenly reverse.

This week, I'm going to discuss both the upside and downside potential in the stock markets. In doing so, I'm going to lean upon the opinions of various market forecasters as well as my best economic resources. I warn you, however, that there is no single oracle of truth and light that has all the answers. George Bernard Shaw reportedly said if all the economists were laid end to end, they'd never reach a conclusion, and I'm beginning to get the same feeling about today's stock market analysts.

Ball of Confusion

The term "uncharted waters" as it relates to the stock and bond markets has probably never been as apt as in today's environment. Unprecedented federal government intervention in the markets has created a playing field that is, at best, significantly different than past market environments. The Fed and Treasury have primed the pump, and we seem to be coming out of the worst recession since the Great Depression. But no one knows whether the economy will continue on a path of sustained growth once these trillions of dollars are no longer flowing.

As we all know, however, the stock market and the economy are two different things and they sometimes move independently. As a result, some feel that the stock market is giving the "all clear" signal for investors with its 50%+ run-up since the March lows. Others, however, point to the fact that stocks haven't risen this far this fast since 1933, and we all know what happened after that. Plus, while this rally is impressive, it's important to realize that the S&P 500 Index is still over 32% below its October 2007 peak value as of the end of September, so many buy-and-hold investors are still under water.

Some analysts point to the fact that the market hasn't experienced even a 10% downward correction since March as a reason for caution, thinking that such a correction could be in the cards in the near future. Others, however, actually think that the market's lack of a significant correction is a sign of the superior strength of this run-up in prices.

There is also a wide range of interpretations of the stock market's current pricing. Some say that the market is pricing in continued economic growth and, if such growth doesn't happen, the market will fall again, possibly even re-testing the March lows. Others, however, claim that the stock market is priced fairly at this point in time and investors need not be concerned.

A number of analysts pin responsibility for the market rally on corporate profits, especially as they continue to beat expectations. Others, however, claim that expectations were so low that they were almost impossible not to beat. Since we don't track or recommend individual stocks, I can't offer an opinion on this earnings discussion. However, I do know that if you lower your expectations enough, earnings are bound to beat them sooner or later.

The end result is that investors are now justifiably confused and there is no single authoritative source for market action going forward. For every positive argument, there's a negative opinion. For every cheerleader, there's a gloom-and-doomer and most are backed up with sophisticated statistical analyses supporting their predictions. As always, the future is unknowable, but in this case it doesn't even seem to be giving us the slightest hint of what might happen.

The Gloom-and-Doom Argument

I am always a little hard on the gloom-and-doom crowd, possibly because I have been exposed to them for so long that I know how wrong they have been over the years. Many in this negative camp missed out on the greatest bull market in history in the 1980s and ‘90s because of their deep-seated fears that the sky was always falling. At best, the old adage about even a stopped clock being right twice a day seems to be appropriate for this group.

However, it's not just the usual suspects who are sounding warnings about the current state of the stock market. Bill Gross and Mohamed A. El-Erian, both with the PIMCO family of mutual funds, are touting a "new normal" where stock market returns will be less than the long-term averages as economic growth is likely to be below-trend (3% or less in GDP) for at least the next couple of years. El-Erian expresses his skepticism of the stock market's recent rally, saying "Interest rates are at zero, there's $2 trillion plus on the Federal Reserve's balance sheet, and yet the economy is still losing jobs. What exactly is the stock market romancing?"

Of course, El-Erian and Bill Gross are well-known bond guys, so it is not unusual for them to be a bit biased against stocks. However, many of my best sources over the years share the view that stocks are likely to under-perform their historical averages over the next several years.

Ned Davis Research recently issued a report noting that all previous rallies of the magnitude we've seen over the past six months or so took place in the 1930s and the 1970s. Davis notes that none of those rallies were sustained over the long haul. In essence, Davis points out that anyone who missed out on the first six months of such powerful rallies, and then jumped back in the market, would have been subjected to losses as the bull market ran out of steam and started falling. This data suggests that the current rally will run out of steam later on this year, but that remains to be seen.

A recent Wall Street Journal article noted that Tim Hayes, chief strategist for Ned Davis Research, believes that there is a good chance that the stock market could have another big decline in 2010. Mr. Hayes is known for having forecast the current market rally, so his opinion does carry some weight. Likewise, Jordan Kotick with Barclays Capital in New York expects a repeat of the 1970s, where the rally fizzles and we end up with an extended range-bound market.

A separate article in the October 5 Business Week noted that high unemployment and low inflation might lead to a decline in pay, which could slow consumer spending in the next year and, in turn, the economic recovery. Mainstream economists downplay the probability of this happening, but it is a possibility, and stock prices could suffer if it comes to pass.

As for consumer spending, a recent Careerbuilder.com survey indicated that 61% of Americans say they are living paycheck to paycheck, up from 49% a year ago. Even among those making over $100,000 per year, 30% say they are just scraping by, compared to 21% a year ago. With a growing number of families strapped for cash and unemployment expected to peak at over 10%, please tell me how consumer spending is going to rebound sharply.

A final cautionary word comes from those analysts who are tracking the massive spending by the federal government. As I have mentioned a number of times, this short-term spending could lead to long-term catastrophe, especially if the Treasury has to raise interest rates paid on its debt to attract foreign buyers. Higher interest rates could stifle an economic recovery already facing headwinds from curtailed consumer spending and high unemployment.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Damn the Torpedoes, Full Speed Ahead!

While there are many reasons to be cautious about the market's recent strong rally, the number of analysts and professional money managers who are cheerleaders for the new bull market is growing. A recent Financial Advisor Magazine article noted that such luminaries as Byron Wien (Chief Investment Strategist for Pequot Capital Management), Barton Biggs (Manager of the Traxis Partners hedge fund), Steve Leuthold (Leuthold mutual funds manager) and Michael Price (billionaire value investor and fund manager) are all now firmly in the bull market camp. Despite the 50+% spike since March, these well-known stock market mavens believe the bull market should continue.

The primary supporters of a continued market rally are those who believe that the market will revert back to its previous long-term mean return. These analysts admit that the last 10 years have been anything but normal, but they believe that long-term stock market fundamentals should regain control as the economy continues to get better.

Of course, when these "normalists" speak of a return to the mean, they are talking about a 12.9% annualized gain like the stock market produced from 1900 to 1999. But some ask how we can return to "normal" when consumer spending is expected to remain suppressed as the rate of savings continues to increase.

Liz Ann Sonders, chief market strategist for Charles Schwab, says that many investors have underestimated the "bounce-back effect," referring to the tendency of the market to rebound from artificially low points such as the March 2009 lows, which were spawned by panic about the ongoing credit crisis. She also predicts that US exports will rise sharply over the next year, which in her view will help to offset slower consumer spending. She, too, is bullish.

Likewise, Neil Hennessy, chief investment officer of Hennessey Funds, not only thinks that the current market rally will continue, but also believes that we are at the start of a 10-year bull market that will see the Dow Jones Industrial Average doubling by the time it's done. He cites low interest rates that make stocks far more attractive than government bonds, and large amounts of cash waiting on the sidelines as the main reasons for his optimism.

Trillions of Dollars Sitting in Cash

The amount of money on the sidelines in cash and money market accounts is a recurring theme when researching stock market analysts with bullish views. As noted earlier, there is reportedly anywhere from $3-$4 trillion sitting on the sidelines, much of it waiting for a signal to jump back into the market. Like Hennessy, many analysts believe that investors will tire of earning little or no return on this money, and then move back into the market, thus leading to higher stock prices.

I have to agree that so much money on the sidelines is a potentially good bullish argument. In fact, some of this money is already flowing back into mutual funds, but industry data show that most is flowing into bond mutual funds, not stock funds. Therefore, it may be a little early to pin too much hope on the herd instinct driving the market up.

Plus, much of this money belongs to Baby Boomers whose retirement funds have already endured two major bear markets in the span of a decade. Many of these individuals may feel that the bulk of the bull market has passed them by, and fear that getting back into the market may expose them to even further losses.

As for government spending and deficits, there is no doubt that much of the economy's growth since the 9-11 terrorist attacks has been fueled by government spending of one kind or another, aided along the way by the housing bubble. As the Fed continues to hold interest rates to near-zero, it is essentially making cash and money market funds unattractive to investors in hopes of driving them to other investments. The question then becomes what happens after the government stops priming the pump?

Fed chairman Bernanke has indicated that interest rates will stay low for a long time. In the past, this liquidity has gone to fuel bubbles – first the tech bubble and then the housing bubble. This time, the bulls believe it will take the form of a stock market bubble, which could send the market much higher in the weeks and months to come. That remains to be seen.

Looking at the Big Picture

As discussed above, there are compelling arguments for both the bullish and bearish cases at this time. However, there is little disagreement that the major stock market averages are "overbought" at this time. As noted earlier, there has not been even a 10% downward correction since the March lows.

The Dow Jones Industrial Average peaked in October 2007 at just over 14,000. It then experienced the largest numerical decline in history over the next 18 months to the low on March 9, 2009. The percentage decline from peak-to-valley was apprx. 54%. From the March low, the Dow spiked up to above 9,800 briefly in late September, marking a recovery of just over 50% without so much as a 10% downward correction along the way.

This is why most market forecasters agree that the stock markets are overbought. From the highs in late September, the Dow retreated to just under 9,500 in early October, but is again rallying so far this week.

One point is clear from the chart, however. Buy-and-hold investors who rode the market all the way down have not recovered even half of their investment losses, despite the latest 50% rebound. And there is no guarantee that the market will continue higher.

Investors that bailed out of the market late last year or early this year, and have not gotten back in, are between a rock and a hard place, as the saying goes. They are understandably reluctant to jump back in the market after a 50% spike up. Yet they are earning next to nothing in cash. I've had plenty of people voice this concern to me: Well, if I get back in now, that means the market is sure to go down again. Those on the sidelines are in a really tough spot right now.

Is the Market Defying Gravity?

As I have mentioned many times, my firm recommends a number of actively managed investment programs that have the flexibility to move to cash or hedge long positions. To provide the most value for our clients, we are also constantly tracking other active money managers to see if their strategies might have a place in our AdvisorLink® Program.

This tracking of current and prospective investment programs allows us to see a lot of daily trading activity generated by a wide variety of systematic approaches, which I believe supports the idea that there are a lot of contradictory signals being given by the market. From our experience, it's not uncommon for the various systems to disagree about the market's direction. After all, they use a variety of technical and statistical data to generate their trading signals, but not all systems use the same data.

However, when we see most of the various programs we track line up on the same side of the market, it usually means there is a good chance the market will move in that direction. Yet as noted above, the current market has been giving numerous contradictory signals, and thus some of the managers we track (and even some we recommend) have been on both sides of the market recently.

This makes it even more difficult to have a strong view of the market's overall direction going forward, other than the consensus that it is currently overbought and overdue for a downward correction. Whether or not we are in such a correction as this is written is uncertain.

The last time something like this happened was back in the late 1990s when the tech bubble was being inflated. Most everyone agreed that the markets were overbought, but stocks, especially tech stocks, continued to soar. New-age market gurus claimed that we were in a "new paradigm" and that the old rules no longer applied. Eventually, the market did collapse under its own weight, but only after an extended period of impressive gains.

We may, again, be dealing with an irrational market that neglects proven technical indicators and, instead, believes that we have entered a new era of government funded gains in the stocks of companies deemed "too big to fail." However, I think there is still a lot of risk for those considering traditional buy-and-hold investment strategies.

It may be that the recent uptrend in stocks continues for a while as it does appear that we are coming out of the recession, and corporate earnings have been surprising on the upside, generally speaking. Consensus opinion has turned significantly higher and, as noted above, there are trillions of dollars looking to get back in that could limit downturns and drive prices even higher.

But with the Obama administration on track to double the national debt in the next 10 years, I don't see things ending pretty at some point, probably soon after all those sidelined trillions jump back in the market.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Conclusions

As I researched material for this article, I found it interesting that the current opinions about the strength of the current market rally somewhat parallel what was going on back in the late 1990s. Back then, all of the fundamental analysis was showing that the market shouldn't be going up like it was, while the "new paradigm" crowd was saying it's different this time.

Now, we have many of the same arguments. The fundamental analysis camp is saying that the market is fairly priced and should continue to go up based on profit expectations. All the while, those promoting the "new normal" are claiming that even if the market continues higher, it will struggle and will under-perform its historical averages. It seems that the more things change, the more they stay the same.

Of course, there is a third possibility that could prove both camps wrong. There is a distinct possibility that the stock market could get caught up in a broad trading range in which it moves generally sideways for an extended period of time. Maybe we're already in it: the Dow's close at 9,487.67 on Friday, October 2nd was actually lower than the index's closing value of 9,505.96 back on August 21st.

Such a market environment does not mean that stock prices do not change, but rather that short-term upward trends could be followed by similar periods of downward price movement, and vice versa. Over the long haul, the market could grind slowly higher or lower, but any such move could be gradual, at best.

Of course, these arguments don't help investors who are trying to figure out what to do with their money. Have they missed out on most of the market's gain, or is there plenty more to go around? Unfortunately, no one knows for sure, and anyone who tells you they do is either dishonest or delusional or both.

As always, I suggest that you have most of your stock and bond portfolio professionally managed by Advisors that have a proven system, complete with the ability to move to cash or hedge long positions during major market downturns and bear markets. More sophisticated investors may also want to consider a small allocation to investment programs that can go "short" if market conditions warrant.

Two of the programs I have mentioned most often are Niemann Equity Plus and Potomac Guardian. These are managed accounts that invest in a wide variety of mutual funds in up markets, but also have the ability to move to cash or hedge positions during major corrections or bear markets. We recently presented a webinar on the Potomac Guardian Program that featured a member of its Investment Committee explaining their approach to the market. If you would like to learn more about this program, I would strongly suggest that you listen to the recorded version of this seminar at the Potomac Webinar link.

For anyone interested in the Niemann Equity Plus Program, we're having a live webinar tomorrow, October 7th, at 12:00 PM Central Time. In this webinar, Travis Silberman, one of Niemann's co-founders, will discuss the strategy Niemann employs in managing money. If you would like to sit in on this webinar, click on the following link to access the Niemann Webinar Invitation.

And don't forget about the Columbus High-Yield Bond Program that I wrote about in my September 15 E-Letter. This actively managed high-yield bond fund strategy offers a fixed income exposure for your portfolio along with the ability to move to cash in down markets. For a more aggressive fixed income program, you may want to check out the Hg Capital Long/Short Government Bond Program that trades the 30-year Treasury bond both long and short.

These are in addition to our other AdvisorLink® recommended programs like Third Day Advisors and Scotia Partners that I have also written about in the past. If you'd like to find out how these programs could bring additional diversification to your portfolio, check out our website at www.halbertwealth.com. Better yet, give one of our Investment Consultants a call at 800-348-3601 and let them explain our various investment options and how they might fit within a diversified portfolio.

Very best regards,

Gary D. Halbert

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Coming From Behind - Investment Lessons From Sports

Gary D. Halbert — Tue, 02 Jun 2009 19:06:29 GMT

IN THIS ISSUE:

Update on My "Coaching Career"
Investors Playing Catch-Up
Remember The Object Of The Game
Don't Forfeit The Game
Have A Good Offense And Defense
Player Selection

Introduction

Back in 2006, I wrote an E-Letter that applied sports analogies to the investment world in an attempt to create a better picture for how you should manage your investments. Because of the extent to which I have been involved as a coach in my son's and daughter's sporting activities over many years, I found that E-Letter to be both very interesting to write, and it was popular with my readers.

This week, I want to revisit the sports analogy because the investment world has changed substantially since 2006. After reaching a peak in October of 2007, stocks were hit by a bear market that continues even as this is written. Between October of 2007 and March of 2009, the S&P 500 Index lost over 50% of its value. Even worse, 2008 saw most bonds suffer losses right along with stocks, something that Investing 101 tells us shouldn't happen.

As a result, many investors have had their portfolios decimated. Putting it in terms of our sports analogy, they are losing the game and have no idea how they might stage a comeback. With that in mind, let's revisit some of the analogies I discussed in my previous E-Letter, as well as some new ideas that might apply to your more recent investing experience.

A Personal Coaching Update

Before launching into a comparison of sports and investing, I thought I'd update you on my personal coaching activities that served as the springboard to the original sports analogy E-Letter article. My long-time clients and readers will recall that I got involved in coaching youth sports over a decade ago, and it has been one of the greatest blessings I have ever had in my life.

It all started when I took my son to his first tee-ball practice many years ago, and I noticed that there was only one coach and about 15 kids, some of whom didn't even have their gloves on the correct hand. So I stuck around to help until the other coaches arrived. No one else ever showed up. Soon, I was given a cap and tee shirt and was designated as the assistant coach. Little did I know that I would go on to coach not only baseball but also football and basketball for years thereafter.

I was not a jock in college, so I was hardly a candidate to become a good or successful coach. As a result, I have stacks of videotapes on coaching youth sports in my closet, which I used to educate myself on how to coach the various sports. Thus, whenever I say that you should "do your homework" in relation to investments, this is the kind of thing I'm talking about.

I continued to coach my son's baseball team in high school at the private Christian school he attended and where my daughter still attends. I even helped out with the football team for several years, which went on to win a State Championship. However, when my son graduated high school last year, I thought that would be the end of my coaching career. To my surprise, the school asked me to help coach the baseball team again this year, and I happily agreed. See photo of "Coach Halbert" with some of the baseball players and coaches at the end-of-season party late last month. Needless to say, coaching sports has been a real joy in my life.

All of this background is to say that I am more than just a casual observer in regard to the nuts and bolts of coaching, and have found that my coaching activities are sometimes similar to my role as an Investment Advisor. In other words, the role I play in my clients' financial planning is that of an investment coach. For the last 30+ years, I have been helping clients with their investments, educating them and steering them toward professionally managed investment products.

In essence, I'm trying to do the same thing with investors that I try to do in sports practices and on the playing field: coach them to be more successful. This has never been more important than now, when many investors are finding themselves at the brink of defeat at the hands of the worst bear market since the Great Depression.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Investors Now Playing Catch-Up

One of the most frustrating parts of coaching is getting way behind in a game. It not only takes scoring a lot of points just to catch up, but can also lead to emotional reactions by players who give up and simply want the game to end. It goes without saying that many investors now have a lot of lost ground to make up, and I am concerned that many of them seem to be giving up on meeting their investment goals.

As the recent bear market has led to significant losses, some investors have started to focus on their own emotional reactions and have taken their eyes off of the ultimate goal. Emotions can be the enemy of sound investing just as they can lead to defeat on the field. I'm sure all of us have witnessed overconfident teams that build a big lead only to eventually lose the game, or teams that get so far behind that they hang their heads and just wish for the game to be over.

In sports, attitude is a big part of a successful program, and it can be a big part of recovering from an economic setback in the investment game. No, having a positive attitude won't miraculously lead to market gains, but it can lead to taking proactive steps to continue toward your investment goals. Some defeated investors sit and mope about past losses and feel unable to take action, while the winners take steps to learn from their experience and seek out options.

Just as it's not easy to come from behind in a ball game, there's no quick way to make up investment losses. There are things you can do to help get back on track, but there are other actions you can take that may actually hamper your progress toward your investment goals. In the remainder of this E-Letter, I'm going to suggest ways for you to "get back into the game."

Don't Forget the Object of the Game

Whether in sports or while investing, it's vitally important that you remember the object of the game. Perhaps the funniest, yet most frustrating years of coaching were the early ones, where many of the kids did not realize what the game was all about. If you have ever attended a beginners' tee-ball game, you know what I mean. Whenever the ball is hit, it seems that every player on the field takes off after it. They completely forget about playing their positions.

As odd as this may sound, there are many adults who are doing exactly the same thing in relation to their investments. They do not take the time to sit down and determine their long-range goals, and they opt for chasing after the latest "hot" stocks or funds or investment fads, without a long-term game plan or a disciplined strategy.

Other investors think that they have a better understanding of the game, but their focus is misguided. Like the baseball player who ignores his coach's signals and "swings for the bleachers" every time he's up to bat, some investors concentrate on hitting investment home runs and take on way too much risk. A classic example was the "dot-com" boom in the 1990s, and we all know how that turned out.

The same can be true today, as many investors are trying to find investments that can help them "make it all back" quickly. In doing so, they sometimes take on more risk than they would otherwise be comfortable with. While aggressive strategies may be the key to higher future returns, they could also result in losing even more of an already smaller nest egg. I'll discuss more about how to use aggressive strategies later on, but they should never make up your entire portfolio, no matter how good their past performance may be.

Focus on the Fundamentals

I have heard many professional coaches with teams in a losing slump talk about how they are directing their team to focus on the fundamentals. While I realize that the term "fundamentals" already has a meaning in the investment industry, for purposes of this discussion the term "fundamentals" will refer to the basic skills that are required to play any given sport – or construct a diversified portfolio.

In baseball, fundamentals include pitching, fielding and hitting, among others. Football, soccer and all other sports have their own set of fundamental skills. Professional coaches know that it is improbable that any team will be successful unless all players have a grasp of the basic skills necessary to play the game. Sometimes, however, there are pressures and distractions that take players' minds off of the basics.

So, how does this relate to investments? First of all, it means that outside influences can sometimes divert an investor's attention from the basics of good investing. Accordingly, getting back to the fundamentals means to focus on how you got the money to invest in the first place. For most of us, that means working hard and saving money. Until recently, saving money was out of style in the US. As recently as 2005, the savings rate was actually in negative territory. Apparently, many Americans mistakenly decided they could spend their way into a comfortable retirement.

Fortunately, the savings rate is now rising, so the first fundamental that I would encourage you to work on is increasing your savings. Or, said another way, decrease your discretionary spending and live below your means. This also means reducing your debt load along the way. It doesn't do much good to save money while piling up credit card debt. The net effect is still low (or no) savings, since the creditors will always have to be paid off.

Others among us have amassed wealth by building a business. While it's not always possible to rebuild a business from scratch, or start a new business after one has been sold, some entrepreneurs are doing just that now that their nest eggs have been eroded by the bear market. It is rarely an easy path, but it is one that can prevent outliving your money in retirement.

The next fundamental skill of investing is to diversify. Here, unfortunately, many investors have had the misfortune of having some poor coaching in years past. That's because they were led to believe that "Modern Portfolio Theory" (MPT), asset allocation and various other buy-and-hold investment strategies somehow provided sufficient diversification.

Over the course of my coaching career, I have had the opportunity to coach with several very successful former professional athletes. I can tell you, it didn't take long for us non-professional, volunteer coaches to figure out that we had a lot to learn. To this day, I still see volunteer Dads teaching kids things that are either wrong or outdated.

Much the same is true, in my opinion, when it comes to most stockbrokers and financial planners who broadcast Wall Street's buy-and-hold mantra across the country. Accompanied by flashy proposals and sophisticated sounding reports like "correlation matrices" and "Monte Carlo simulations," these promoters sold an entire generation of investors on the idea that allocating assets among a group of stock and bond asset classes would protect them in a market downturn.

What they didn't count on was that many of these historical relationships often break down in a bear market, just when they're needed the most!

As we now know, this poor attempt at diversification didn't work in the 2000 – 2002 bear market nor has it worked in the one we're in right now. Yet, many of these buy-and-hold adherents continue to counsel their clients to "keep running that play until you run it right." In other words, stay invested and hope that you don't need your money until the market recovers.

Fortunately, many investors have now realized that true diversification means having a variety of investment strategies in a portfolio, not just a collection of securities that happen to fit in different sections of the Morningstar style box. Specifically, active management strategies that can move to cash or hedge in down markets are catching on like wildfire because they have historically offered true diversification, many with low correlation to the equity markets.

Monitor Performance Regularly &
Make Changes When Necessary

Professional sports franchises spend a huge amount of time, effort and money to monitor and evaluate the performance of their superstar athletes. They know that a weakness, if left unchecked, can mean the difference between winning or losing a game – or even a championship! Likewise, investors should make it a priority to monitor the progress of their investments, but I have found that this important step is often overlooked.

Over the years I have been surprised at how many investors don't monitor the performance of their various investments regularly. It is very important to continually monitor your investment performance to insure that you are on track to meet your investment goals. Monitoring has always been an important part of the investment process, but today it is even more critical. Unfortunately, many investors learned this lesson too late to help prevent past losses, especially in the case of the current bear market.

Too many just assume that their broker, advisor or planner will make or recommend changes if they are needed. Unfortunately, this is often not true. Ask yourself, what broker or advisor is going to tell you that you should close your account and move the money elsewhere? Answer: probably none.

Also, many brokers are restricted to selling only those products offered by their firm. In such cases, the broker is not likely to tell you about other investment opportunities that may be performing better, or that may offer much-needed diversification in your portfolio. As noted above, the last thing they want is for you to move your money elsewhere.

Whenever possible, you want your broker, advisor or planner to be independent, with the ability to analyze and recommend a variety of investments or funds from different sources. Typically, such independent advisors are "fee-based" rather than "commission-based." Put differently, you want someone who is on your side of the table, and will not hesitate to recommend a change, if needed.

Here's where my firm can help. We are truly independent. We not only recommend third-party money managers, but we also monitor the performance and trading of each manager on a daily basis. Since I have my own money with every single money manager and program that we recommend, it is easy for us to track their real performance daily.

We compare the performance of my accounts to the published "official" track record and evaluate trading patterns to see that they comply with our expectations for each strategy. We are also in frequent contact with each manager we recommend to make sure that they have not made material changes to their strategy or system.

And finally, because we are independent, we do not hesitate to recommend that you "fire" a manager if the performance does not live up to reasonable expectations, or if they do make material changes to the strategy or system that are untested.

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Add a Little "Razzle-Dazzle"

Almost every football team I have ever observed has at least one "razzle dazzle" play. Also called "trick plays," the term refers to plays that are out of the ordinary and totally unexpected by the defense. Examples have names like the Statue of Liberty play, guard-around play, halfback pass play and my favorite, the flea-flicker.

Plays like this are designed to catch the defense off-guard and, hopefully, lead to a score. In my experience, I have seen such plays shift the momentum in a game and lead to a victory for the underdog. However, just as often, I have seen these plays blow up and lead to a score for the opposing team. In other words, they are risky.

Earlier on, I mentioned that I would discuss how to use aggressive investment strategies to help diversify an investment portfolio. Shifting our focus to the investment world, a good analogy to the razzle-dazzle play would be aggressive investment strategies that employ sophisticated trading techniques. I originally wrote about this concept in my April 14 E-Letter, and I feel that such strategies can bring needed diversification to a portfolio in the right circumstances.

Just as a razzle-dazzle play in football contains something unexpected by the opposing team, aggressive investments often employ sophisticated trading strategies that used to be confined mostly to the secretive hedge fund industry where only the wealthy had access. Today, however, advances in mutual fund design make it possible for money managers and investors alike to access funds that employ leverage, that can "short" various stock indexes and even provide access to markets such as commodity futures and currencies.

These investment strategies are often based on a quantitative trading model developed by a professional Investment Advisor. Using a variety of indicators such as trend analysis, momentum, technical analysis and a host of others, these trading models seek to anticipate and capitalize on shorter-term market moves. To be honest, most of these aggressive programs provide lackluster results, and can have severe losing periods, but there are some such as Scotia Partners and Third Day Advisors who have produced favorable returns over a number of years. Of course, there's no guarantee that they will continue to do so.

When these programs are on a winning streak, they often win big. However, just like the razzle-dazzle play in football, they are risky and can also lead to significant losses. Thus, just as no sports team could get away with running trick plays all of the time, allocations to aggressive investment strategies should be limited, no matter how good their past performance may be.

Have A Good Offense And Defense

Another important analogy between sports and investments is the idea that you can't concentrate on just offense or defense, you have to play both. If you focus too much on one and not enough on the other, you're not likely to win many games. There's an old football saying: "Offense wins games, but defense wins championships."

Over my years of coaching, I have witnessed sports teams that have a fantastic offense, but their defense could not keep the other team out of the end zone. On the other hand, I have also seen teams with strong defenses that couldn't seem to put a score on the board. It just makes logical sense that being strong in one or the other does not necessarily mean you'll win the game.

While this is a common sports analogy, it may surprise you that a number of popular investment strategies used by millions of investors are all offense and no defense. I think most "buy-and-hold" investment strategies Wall Street offers could be described this way. Only if the market goes up do you make money, and when it goes down, you can lose big.

If you have read my E-Letters for long, you know that my main emphasis is on avoiding large losses in your investments. Likewise, you've probably already seen the table below (we publish it often), but it can't be repeated too often in my opinion. The breakeven table below illustrates just how devastating large losses are, and how difficult it is to recover from them.

Amount of Loss Incurred	Return Required To Break Even

10%	11.1%
15%	17.7%
20%	25.0%
25%	33.3%
30%	42.9%
35%	53.9%
40%	66.7%
45%	81.8%
50%	100.0%

This breakeven table is why I like to emphasize active management strategies that can play both offense and defense. Most active management strategies include the flexibility to exit the market (partially or fully) or "hedge" long positions if market trends turn ugly. This is one good way of playing defense in your investments. However, they also have ways to put the offensive unit back on the field through sophisticated strategies for getting back into the market.

Player Selection

Now that we have established that both offense and defense are necessary ingredients on your investment team, it's time to turn our attention to player selection. In baseball, you see teams that can hit the ball well, but lack a good defense in the field – and vice-versa. But it is generally agreed that to win championships, you need a balance of both. On the defensive side, you must be able to field the ball well and make good throws.

In many ways, investing is no different. You are usually best served by a diversified portfolio with multiple investment strategies. However, this is easy to say, and sometimes hard to do. After all, how and where should you invest? What investment strategies should you include or exclude from your portfolio? How do you evaluate the various players to select the best team?

The investment industry is truly one of the most confusing places to try to navigate, sometimes even for experienced investors. There is an overload of investment and market information out there, and much of it is conflicting or outright wrong. We are constantly bombarded with investment information from the mainstream media, cable networks and the Internet, not to mention our mailboxes.

So, how should you go about selecting the most appropriate players for your investment team? Where should you send your scouts? What analysis should you run on each? What performance statistics are the most meaningful, and what "intangibles" exist that might mean the difference between success and failure?

I think most people realize that they do not have the ability to evaluate an athlete's strengths and weaknesses to determine if they should be on a sports team. Yet, these same individuals often feel that they should be qualified to select investments for their portfolio. Why should this be? After all, very few people try to be their own banker, lawyer or doctor, but they seem to have no problem trying to be their own investment manager.

From my 30+ years in the investment business, I think the primary reason many people take on their own investments is that there is an expectation that they should be able to do it, even though there is no good reason why. Perhaps it's the flood of investment information in the broadcast and print media and the Internet that causes this. Or maybe it's a matter of thinking that we should have picked up investment knowledge somewhere during our education.

Unfortunately, this sense of self-direction has led many to adopt "canned" buy-and-hold approaches from the Internet or any of the hoards of "how-to" investment books. Don't get me wrong, some do-it-yourself investors have done quite well, often by applying some form of active management to their portfolios. However, many of the do-it-yourself investors who have contacted us have not fared well over the past decade.

Going back to our sports analogy, what do team owners or schools do when they need someone to evaluate players and put the best team on the field? That's right, they hire a coach!

Good Coaching Makes All The Difference

And now we're back to where I began, with the realization that much of my sports coaching experience relates, to a certain extent, to the investment management services my company offers. As an investment coach, an independent professional Investment Advisor can help investors by:

Scouting out and evaluating various investment managers representing a number of different approaches to the market;
Using detailed investor questionnaires and discussions to develop a playbook designed to work toward his or her individual investment goals;
Assembling a team of independent, professional money managers whose strategies have the potential to work together over time to help moderate the risks of being in the market; and
Monitoring the performance of each Advisor as the game progresses to know when it may be best to send in a substitution.

In sports, it is often true that the best-coached team wins the game, rather than the one with the most talent or ability. The same can be true in the investment world. Many of the funds and investment programs we recommend never hit the "Top 10 Investments" list. Yet, when used to create a diversified portfolio, they can work together in such a way as to provide meaningful risk-adjusted returns and limit losing periods.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Conclusions

Imagine the following scenario: You are attending a football game and the home team is struggling against a worthy opponent. Suddenly, a fan jumps out of the stands, walks onto the sidelines, fires the coach and takes over the team. Not long after, the self-appointed new coach becomes disappointed in his players, so he suits up himself and goes onto the field to play in the game.

Sounds ridiculous, doesn't it? Yet, this kind of thing happens every day in the investment game. Investors often take over the reigns of their investments for one reason or another. Sometimes, they do well, but in many instances, they do not. In my opinion, investors are usually best served when they focus on their jobs or businesses, doing what they like to do and allowing professionals to handle most or all of their investments.

To that end, it would be a pleasure for Halbert Wealth Management to serve as your investment coach. We have been evaluating professional money managers for over 30 years, and we have a team of quality managers just waiting to get on the field for you. And I have an excellent staff of Assistant Coaches (Investment Consultants) that are standing by to help you evaluate your goals and get started. Together, we can handle all or part of your investment portfolio.

If you'd like to learn more about the investment management services we offer, just give us a call at 800-348-3601 or e-mail us at info@halbertwealth.com. Or, you can request that we call you by clicking on our online contact request form.

Wishing you profits,

Gary D. Halbert

SPECIAL ARTICLES:

Obama considers a new "Value-Added Tax" to fund
out-of-control spending & Nationalized Health Care
http://foxforum.blogs.foxnews.com/2009/05/27/kerpen_vat_obama/

Health Reform's Saving Myths
http://www.washingtonpost.com/wp-dyn/content/article/2009/05/29/AR2009052903235.html

Cap & Trade: All Cost, No Benefit
http://www.washingtonpost.com/wp-dyn/content/article/2009/05/31/AR2009053102077.html?hpid=opinionsbox1

On The Economy, Bonds & Bear Market Rallies

Gary D. Halbert — Tue, 05 May 2009 21:15:55 GMT

IN THIS ISSUE:

First Quarter GDP Falls More Than Expected
Stocks Always Outperform Bonds, Right? Wrong!
Should You Put All Your Money in Bonds? No!
Is the Current Market Rally Too Big to Fail?
Conclusions – Not Out of the Woods Yet

Introduction

Last Wednesday the government reported that 1Q GDP declined at an annual rate of 6.1%, thus confirming that we are still in a deep recession. While the GDP report was worse than the pre-report consensus, it was very much in line with what I predicted in my April 21 E-Letter. I continue to believe that we will be in this recession all year.

Several recently released studies highlight the fact that long maturity Treasury bonds have outperformed stocks over the last 40+ years, and by a substantial margin over the last 28 years. I will examine these reports as we go along. Does this mean you should put all of your money in bonds now? I'll tell you why I believe that would be the wrong move to make at this time.

Finally, we get calls every day asking if the recent rally in the stock markets means that the bear market is over, or if this is just a bear market rally. While no one knows for sure, we will take a look at some past bear market rallies to keep things in perspective. I think you'll find this week's letter interesting.

GDP Falls More Than Expected (But Not to My Readers)

The Commerce Department reported last Wednesday that 1Q GDP fell at an annual rate of 6.1%. The pre-report consensus called for a drop of 4.7%, so the actual report came as a negative surprise to the markets (but not to those of you who read my April 21 E-Letter). The decrease in real GDP in the 1Q primarily reflected negative contributions from exports, inventory investment, equipment and software, and decreases in commercial and residential construction.

There were, however, a few bright spots in the latest GDP report, particularly in regard to consumer spending. The GDP report last Wednesday noted that personal consumption expenditures (consumer spending) increased at an annual rate of 2.2% in the 1Q in contrast to a decrease of 4.3% in the 4Q. That number seemed unusually high to me in light of the continued plunge in consumer confidence in the 1Q (more on this below).

Durable goods orders increased 9.4% in contrast to a decrease of 22.1% in the 4Q. Nondurable goods orders increased 1.3% in contrast to a decrease of 9.4% in the 4Q. These are encouraging signs but were overwhelmed by the bad news in the 1Q.

Commercial construction plunged 37.9% year-over-year in the 1Q, even worse than the 21.7% decline in the 4Q. Residential construction decreased 38.0% in the 1Q compared with a decrease of 22.8% in the 4Q. Equipment and software purchases decreased 33.8% compared with a decrease of 28.1% in the 4Q. Exports of goods and services decreased 30.0% in the 1Q compared with a decrease of 23.6% in the 4Q. Imports of goods and services decreased 34.1% compared with a decrease of 17.5% in the 4Q.

The bottom line is that if we had not seen the pickup in consumer spending and durable goods orders, the 1Q GDP number could well have been down 8-10%. The recession is still quite severe, and I continue to predict that it will be with us all year.

It remains to be seen if the next 1Q GDP update on May 29 will include a downward revision from the -6.1% number reported last week. If so, that may not be good news for the markets.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Stocks Always Outperform Bonds, Right? Wrong!

The conventional wisdom going back over a century is that stocks outperform government bonds over time, right? Surely most everyone reading this has been taught that axiom over the years. It's your basic Investing 101 gospel. It's also the financial planning gospel. It goes like this: stocks are more volatile than bonds, but they deliver a fairly significant return premium over bonds in the long-term. Since government-backed bonds are considered safer, if held to maturity, then it only stands to reason that they would deliver somewhat lower returns than stocks over time.

So as a general rule, you should invest more heavily in stocks over bonds when you are younger and have lots of years to ride out the occasional bear market. Then, as you get closer to retirement age, you begin to scale back your equity allocation and invest more in government bonds. Many traditional asset allocation and financial planning models suggest something in the range of a 60/40 stocks/bonds split when you are younger and over time moving to a 40/60 stocks/bonds split – and then even more in bonds as you hit retirement.

Yet this conventional wisdom has come under increased scrutiny recently. Why? Since we've had two serious equity bear markets in the last decade, Treasury bonds have now outperformed equities over the last 30-40 years. Many financial academics and Investment Advisors are now seriously rethinking their long-held beliefs about bonds. (You might note that yours truly never believed you should have all of your money in stocks and bonds only, but that's another story for another time.)

Given the severity of the recent stock market debacle, with the benchmark S&P 500 Index plunging almost 45% since the peak in late 2007, the long-term performance numbers for stocks-versus-bonds have changed. Government bonds now have somewhat higher returns than stocks, especially over the last 30-40 years. Let's look at the numbers.

If we look back from 1801 (for some reason this is a popular historical date) to today, stocks did beat government bonds by apprx. 2.5% per year on average, which is huge considering the compounding effect over more than two centuries. This is the basis for claims that stocks beat bonds over the long-term. But these days, the “long-term” is hardly measured by multiple centuries. Today, a long-term investment horizon is more typically three to five years, or 10 at tops.

But even if we are to look back 200+ years, we see several long periods in which Treasury bonds beat stocks, including the last 30-40 years. Bonds outperformed stocks in the following time windows: 1803 to 1871 (68 years); 1929 to 1949 (20 years);and yes, 1968 to 2009 (41 years).

The implications of this are quite interesting. While Treasury bonds can be quite volatile at times, they always pay off in full if held to maturity. Stock investors have no such guarantee. As a result, stocks are supposed to provide a “risk premium” of a couple percentage points or more, at least historically, to pay for that chance their price could drop (potentially to zero).

Yet as noted above, stocks have not lived up to that historical expectation over the last 30-40 years, not to mention the current bear market. Based on the actual returns in stocks and bonds over that period, you could have chosen one of the safest investments in the world and performed better than those following Wall Street's buy-and-hold forever mantra (which I have never believed should be one's only strategy).

Bonds Really Outperformed Over the Last 28 Years

Economist and author A. Gary Shilling recently published an interesting study on the performance of stocks versus bonds over the period from 1981 to early 2009. For purposes of illustration, Shilling assumed that one bought a 25-year zero-coupon T-bond at the all-time low in October 1981 when long-bond yields were well above 14%. Each year thereafter, he rolled it into another 25-year bond to maintain the 25-year maturity and reinvested the income.

By comparison, Shilling assumed that one bought the S&P 500 Index at its low in July 1982 and reinvested the dividends each year. Then he tracked the performance of both investments through the end of March 2009. The results are quite surprising! Of course, keep in mind that we have seen one of the largest declines in interest rates and inflation in history over the last 28 years, along with two major bear markets in stocks in the last decade.

Shilling found that the 25-year zero-coupon bond delivered an average annual return of 20.4% over the 28 years, while the S&P 500 gained an average of only 10.7% annually over the period from 1981 through March 2009.

If you would like to review Shilling's study (that was printed in Forbes recently) in more detail, I have provided a link to it below in SPECIAL ARTICLES.

Actually, you can go all the way back to 1969 and long-bonds (Treasuries with 20-year or longer maturities) still beat the S&P 500, but only by a marginal amount.

So, Should You Put All Your Money in Bonds? No!

Given that bonds almost doubled the returns of the S&P 500 over the last 28 years, and given that the S&P 500 fell 37% last year and is still down in 2009, you might think it's time to put all or most of your money in Treasury bonds. I do not recommend doing so. First of all, interest rates today are the lowest in many years.

The 20-year and 30-year Treasury bond yields are currently well below 4%, which is extremely low. The 10-year T-bond is well below 3%. Sooner or later the inflation threat will sink in, and bond rates will rise, possibly significantly.

With trillion dollar budget deficits as far as the eye can see, and with other trillions being spent on bailouts, toxic asset purchases, etc., there is little doubt that the US will experience a significant increase in inflation in the years ahead. Some fear we will see hyperinflation given the unprecedented spending by President Obama. Therefore, now could be one of the worst times to load up on Treasury bonds.

Stocks, on the other hand, remain quite depressed. The S&P 500 Index is down apprx. 45% from the highs back in late 2007. While no one knows if the early March lows are “the bottom,” stocks are much cheaper in terms of value today than are bonds, which are in my opinion over-valued.

The question before us is not what happened over the last four decades, but what might happen in the future. One Internet blog entry that I read noted that a call to invest in bonds right now may be similar to John Bogle's (of Vanguard fame) advice in the late 1990s to buy a S&P 500 Index fund and hold it for the foreseeable future. Given that we have experienced two major bear markets since then, that advice was obviously wrong!

There are several bond studies coming out that basically reach the same findings as Gary Shilling's numbers quoted above. So bonds are getting a LOT of attention of late. While all this attention is almost sure to drive more investors to bonds, I would not follow the crowd by selling stocks and equity mutual funds to buy Treasury bonds, which will go down in value if interest rates rise.

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Is the Current Market Rally Too Big to Fail?

We have heard a lot since last year about institutions that were deemed “too big to fail” and were thus eligible for billions in government bailouts. While it's admittedly a bit different in the stock market, there are market analysts and investors who are claiming that the sheer size of the recent market rally means that the bear market is over and happy days are here again; in other words, this 25% rally is “too big to fail.” While all of us would like to believe that the bear market has run its course, I'm afraid that we can't make that judgment based on the size of the recent rally.

To illustrate this point, I'll reference an excellent example that I came across the other day. The illustration begins with a question: What would an investment of $100,000 be worth if it was invested over a three year period that benefited from the following stock market rallies.

+48.0%
+23.4%
+27.6%
+35.0%
+24.6%

The natural inclination is to assume that the $100,000 would be worth far more at the end of the three-year period. Compounding the original $100,000 investment by the returns above results in an ending value of almost $400,000. However, we know that markets don't go straight up, and there were also some down periods during this timeframe. So we have to reign in our guess to something less. So, what about $200,000 to $250,000? That sounds like a reasonable range, doesn't it?

Well, the correct answer is only $10,800! Yes, over this particular three-year period, $100,000 invested in the Dow Jones stocks would have lost almost 90% of its value.

Surprised? Shocked? I have to admit that this illustration is somewhat of a trick question because it conveniently leaves out the fact that these market rallies occurred over the three years between September 1929 and July of 1932, the darkest period ever for the US stock markets. During this time, the down periods were far worse than the market rallies, so a $100,000 investment in the stock market lost over 89% of its value.

While the above illustration is designed to generate a surprise reaction, it also makes a very important point in regard to bear market rallies. Very rarely do bear markets go straight down, just as no bull market goes straight up. There are almost always “corrections” in the short-term trends, and these reversals are frequently large enough to convince investors that the major trend has changed as well. This can be very costly, especially if they make a change, only to find that the correction was just that, and then the major trend continues.

After the Crash of '29, there were several powerful market rallies that followed. Just as now, I'm sure there were stock market pundits back then claiming that a new bull market had surely begun during some of these rallies, especially the one in late 1929 to early 1930 that gained 48% over the course of 22 weeks.

While the 1929–1932 period was the most prominent example, other notable bear markets have had strong rallies that proved to be false alarms. One Internet source I consulted noted that the 1973–1974 bear market had two bear market rallies of apprx. 10%, and the 2000–2002 bear market had three substantial rallies with the smallest being 19%.

Even the current bear market that began in October of 2007 has had four double-digit rallies, including the one we're in right now. Each of the preceding rallies has provided hope to market participants and drawn many of them back into the market, only to see their investments dwindle further.

As I have mentioned in these pages several times, I am not sure that we have seen the end of this bear market, especially if we learn in the coming weeks that some or many of the largest insurance companies are in trouble. While I am willing to consider the possibility that the March 9 low was the bottom of the market, I also believe that we are very likely to at least retest this low again in the future.

A good example of the market retesting its prior lows is the period of time from July of 2002 to March of 2003. The statistics on the 2000–2002 bear market indicate that the S&P 500 Index hit an intra-day low of 768.67 in October of 2002. However, when you look at a chart of the S&P 500 Index during that period of time, you see that we came very close to the October 2002 intra-day low in July of 2002 (775.96) and again in March of 2003 (788.94). Chartists call this a “triple bottom.” I would not be surprised to see a similar situation occur in 2009.

What Should You Be Doing?

There's an old saying that you should “hope for the best but plan for the worst.” I think that's where we are today in the stock markets. With the unprecedented government intervention in the credit markets and even corporate ownership, we are sailing in uncharted waters. Politicians, who are always happy to see a healthy stock market, now have an even greater incentive to make sure the economy pulls itself out of the ditch. No one wants to run for re-election with the stock market in a slump, especially when the government controls some of the nation's largest banks and corporations.

Therefore, while we all hope that the March 9 low set the bottom of the current bear market, we have to plan as though there's more pain to come. There are a number of ways you can do so, including:

If you are fully invested in the market, you have experienced a nice bump in the value of your portfolio recently. Not knowing what lies ahead, you may want to consider taking advantage of the rally and moving some of your investments to cash. This way, if the market continues to rally, you'll still participate in the gains but with less exposure. However, if we retest the March 9 lows, you'll have some money on the sidelines out of harm's way.
If you are totally on the sidelines in cash, then you have probably been spared some of the bear market's losses, depending upon when you cashed out of the market. However, you have also missed out on the recent market rally. Don't let this regret grow into an emotional need to jump into the market. You could be setting yourself up for losses if we retest the March lows.

If you feel you must get back into the market in some way now, I would suggest that you “dollar cost average” into the market. This is a strategy that calls for making partial investments over time rather than committing your whole portfolio at once. That way, if we retest the March lows, not all of your portfolio will be affected.
Finally, I suggest that you consider the actively managed strategies I recommend that have the flexibility to move to cash or hedge long positions during market downturns. This professionally managed approach takes away the worry and hassle of deciding whether to be in or out of the market. Since I have written about some of these managers in the past, I'll not go into detail here. Suffice it to say that professional active money managers seek to position your portfolio to participate in up markets but become defensive during market downturns.

In light of the current stock market situation, I am reminded of a conversation I had many years ago with a very successful active money manager. We were discussing the higher management fees charged by active managers, typically in the 2-2½% range annually. I made the comment that I believed such fees were justified in return for getting investors out of the market during serious downturns. The manager responded as follows (more or less verbatim):

You know, most people think they pay us our fees to get them out of the market to avoid the big declines and bear markets. But getting out of the market is the easy part. What people really pay us for is to get them back in the market – that's the hard part.

That conversation comes to mind because we hear from so many people who got out of the stock market late last year or early this year, and they have no idea when to get back in. That's when having a time-tested mechanical timing system directing a portion of your portfolio can be very valuable.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc.
are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

Conclusions – Not Out of the Woods Yet

Following the release of the 1Q GDP report last Wednesday, the Dow Jones promptly rallied 200 points, and the S&P 500 gained 22 points – even though the overall GDP report (-6.1%) was worse than expected. People reacted to the increase in consumer spending in the 1Q as a sign that the recession may be ending.

Yet if we dissect the numbers within the GDP report, as I did above, we find that most sectors of the economy declined at an even faster pace in the 1Q. These facts suggest that this recession has not hit bottom and will be with us for some time to come.

It may be that the 1Q proves to be the worst part of the recession. Most economists expect the decline in GDP to be smaller in the 2Q and even smaller in the 3Q. While those estimates may prove to be correct, we saw no convincing evidence that the recession was starting to bottom in the 1Q. Given that, I think we can dismiss forecasts calling for a return to positive GDP in the second half of this year.

Also keep in mind that there may be more bad news for the credit crisis just ahead. As I discussed at length in my April 7 E-Letter, there is plenty of evidence that some of the largest insurers in the US are in financial trouble. Some are pleading for bailouts, and it is probably reasonable to expect they will get them. But this news is getting hardly any media attention thus far. So this could be the next shoe to drop in the credit crisis.

Obviously, it is very difficult to know what to do with your investments in times like these. Investors who are on the sidelines wonder if they should jump back in. People who rode the market all the way down are wondering if they should now get out. Based on the calls we get, most investors are still very nervous, even though the stock markets have recovered somewhat.

In my Investment Advisory business, we have found that investors mostly want to talk to someone they can trust and explore all of the options. They don't want to talk to someone who is automatically going to tell them to sell all of their investments and transfer their money to a new Advisor or program, nor do they want to be hounded on the phone or via constant e-mails. Fortunately, we don't do any of those things at my company.

I would like to offer you the ability to talk to any of our Investment Consultants about your investment needs with no cost or obligation to invest of any kind. My company is very different in that all my Investment Consultants are paid a salary, and do not receive commissions or incentive compensation of any kind. Thus, their marching orders are to make sure that our clients' investment needs are met, even if it means not participating in any of the investment programs we recommend.

If you would like to discuss your current investments and/or retirement planning with someone who is not going to pressure you to invest with them, then you are welcome to call one of my experienced Investment Consultants, at no charge to you. You can call us at 800-348-3601, or if you prefer, you can send an e-mail to info@halbertwealth.com and your questions will be immediately routed to one of our staff members.

Wishing you profits,

Gary D. Halbert

SPECIAL ARTICLES:

Gary Shilling Study: Stocks vs. Bonds
http://www.forbes.com/2009/04/22/treasury-deflation-stocks-personal-finance-guru-insight-gary-shilling.html

More on the Financial Stability Board
http://spectator.org/archives/2009/05/04/the-fed-fails-upward

Beware: Bear Market Brings Out Tall Tales!

Gary D. Halbert — Tue, 03 Mar 2009 22:39:52 GMT

IN THIS ISSUE:

Two Valuable Investment Articles To Share
Stocks Hit 50% Drawdown In February
Investors Naturally Seeking Guidance
Some Buy-And-Hold Advice Is Misleading
Another Active Money Manager Doing It Right
Conclusions – Don't Be Misled

Introduction

As I have noted many times in past E-Letters, my staff and I read a ton of material every week. This week, I want to bring two recent articles to your attention. Each of these articles is on the subject of investing, with one from the Wall Street Journal and the other from Investor's Business Daily. While they have very different subject matters, they are related in a way that I'll make clearer as we progress through the E-Letter.

The first article from the Journal provides a snapshot of just how badly the stock markets have performed in 2009. While many believed that stocks would stage a rally in early 2009 based on a variety of factors, the equity markets have plunged instead. With that being the case, investors are asking what they should do in light of the market's drop.

That's where the second article comes in. It's an article from Investor's Business Daily that is little more than a shill on behalf of large mutual fund firms. It purports to illustrate why timing the market is a bad thing, but it is so skewed in its analysis that one of our fellow Investment Advisors called it “…so bad it's funny.”

Unfortunately, it's not funny for those who are locked into investments that have continued to plummet in value, yet the only advice they get is to “stay the course.” That's why I'll end up this week's E-Letter with an analysis of one of the actively managed investment programs that I have written about in the past.

Stocks Dropping Like A Rock

The first article I'd like to bring to your attention is from the February 24 edition of the Wall Street Journal. The headline says it all: “Stocks Drop to 50% of Peak.” The day before the article was featured, the Dow closed at 7114.78, down by about half from the October 7, 2007 high close of 14,164.53.

Clearly, the stock market has not been impressed with the efforts so far to address the credit crunch and reverse the economic recession in which we now find ourselves. Since the article was written, the Dow rallied a bit, but then continued its downward slide, closing out the month of February even lower at 7062.93. As of the end of February, the Dow was down over 19% year-to-date in 2009 and stood at a loss of just over 50% from its October 2007 peak, and things have gotten worse since then.

The S&P 500 Index, one of the most widely followed of all stock market benchmarks, is actually worse off than the Dow. From its peak value of 1565.15 on October 9, 2007, the S&P 500 hit a 50% drawdown in November of 2008, and then hit another new low for this bear market of 743.33 on February 23, a drop of over 52%. As of the end of February, the S&P 500 Index stood at 735.09, down over 18% for 2009 and down over 53% from its peak in late 2007.

I have provided a link to the full WSJ article under the Special Articles heading below my signature. I encourage you to read it over to glean additional details about how various sectors of the market have performed. Obviously, it remains to be seen when the markets will hit bottom and begin to recover.

Looking back, much has been said of a “lost decade” in the stock market. Unfortunately, we're now pushing even further back to find comparable values for the major market indexes. The Journal article notes that the major market indexes are revisiting values not seen in more than 11 years. That's a zero net gain for a period of over a decade, which is not what they tell you to expect in the buy-and-hold propaganda.

More recent market action has now taken the S&P 500 Index down to October 1996 levels, dropping the Index value to just over the 700 mark. The S&P 500 Index now stands at 55% below its October 2007 peak, which means that index investors will have to make returns of over 122% just to get back to break-even. The Dow is in similar shape, needing returns of apprx. 110% to get back to where it was in October of 2007.

Investors Are Seeking Guidance

Needless to say, investors who still have money in the markets have continued to see their account balances fall in 2009. With all the talk of a rally in early 2009, there is widespread concern and disappointment. Now that the major market averages have fallen to new lows, many investors are wondering if they should bail out now or hang on and hope the market finds its footing soon.

At the same time, investors who have already moved to cash are asking if now might be the time to get back in. As noted above, as of the end of February the S&P 500 Index is down over 18% year to date, and the Dow is in even worse shape with a year-to-date loss of over 19%. Thus, investors who are on the sidelines are wondering if we're now at a point where they should jump back into the market. I suspect a large percentage of them are paralyzed with fear, not knowing how much further the market may have to fall.

Fortunately, the message I have been giving ever since I started writing this E-Letter has hit home with many of my readers. I have always suggested using active money managers who have the ability to move to cash or hedge long positions as opposed to buy-and-hold strategies that just tell you to take losses in stride. We are as busy as we have ever been – handling phone calls, e-mails and website contacts from investors who are now anxious to learn more about our active management strategies.

You see, with active management strategies you don't have to worry about when to get in or out of the market. Our professional active money managers handle those details for you. Thus, no matter whether the market starts back up or continues its decline, you know that you have an experienced professional on your side. In addition, you also know that you have my firm monitoring the managers on your behalf.

Bad Advice From A Good Source

Unfortunately, however, not everyone has jumped on the actively managed bandwagon. As I noted in my January 27 E-Letter, buy-and-hold is not going down without a fight. Many investors are getting poor advice, sometimes based on misleading “studies” that are little more than blatant attempts to keep investors in the market as long as possible, despite the negative consequences. And sometimes this ill-fated advice comes from well-respected sources.

A case in point is the Investor's Business Daily article that I mentioned above. On February 18, the IBD ran an article in their Investment Trends section that provided a very one-sided view of buy-and-hold versus market timing. The article summarized a study done by a large mutual fund company that showed the superiority of “dollar-cost-averaging,” which is a buy-and-hold strategy, to their interpretation of market timing. It was entitled “When Buy-And-Hold Beats Bad Timing,” and it was little more than a hit piece on active management from the beginning.

The study is fatally flawed, in my opinion, as I will discuss in more detail below. Such flawed studies are nothing new for the mutual fund industry, since after all, it's in their best interests for clients to stay invested (even though it may or may not be in the clients' best interests).

What bothers me the most, however, is that a well-respected publication like Investor's Business Daily chose to serve as the marketing arm of a giant mutual fund family by publishing a study that they had to know included dubious assumptions. Whatever happened to objective financial journalism where assumptions were analyzed rather than just accepted at face value? I will dissect the study and show you why it is faulty below.

Here's the scenario depicted in the fund company study. An investor has $10,000 of accumulated value in the stock market on January 1, 2000 and then decides to make $500 monthly contributions under a dollar-cost-averaging plan going forward. The study assumes that all investments will be made into the S&P 500 Index (which is not possible in reality, but is OK for the purposes of an illustration). The study tracked the ongoing performance from January 1, 2000 through the end of January 2004.

Using various assumptions that I will critique in more detail below, the study concluded that investors would have been better off had they stayed invested in the market during the entire 2000 – 2002 bear market than if they had followed any of three different market timing strategies. Keep in mind that these are not real market timing strategies, but rather just completely hypothetical scenarios dreamed up by the mutual fund company.

Anyway, according to the article, by the end of January 2004, the buy-and-hold investor would have had $33,502 of value as opposed to $33,357 for what the study called the “Bear Market Dodger,” $31,799 for the “Bear Market Refugee” and only $31,616 for the “Doomsday Capitulator.” Cute names, don't you think?

In my analysis, I concentrated on just the first market timer category, the “Bear Market Dodger,” since doing so will allow me to simplify the calculations and stay within the space I have to discuss this issue. Under this scenario, the investor becomes nervous about the market in early 2000 and elects to make all ongoing monthly contributions of $500 to cash instead of into the market. Then, in January of 2004, the Dodger jumps back into the market with both ongoing contributions and accumulated cash.

I had my staff run the numbers again from scratch using the study's basic assumptions. Unfortunately, we were unable to duplicate the exact numbers published in the study, but we got close. We were using month-end S&P 500 Index total return numbers while the study's authors may have used daily returns, so this could account for the slight difference. We then ran scenarios that corrected the flaws we identified in the assumptions. I will discuss the results of our alternative calculations in more detail below.

Many investors and even financial professionals would just take the study's numbers at face value without further critical thought. However, I believe the mutual fund study has a number of flaws that make its conclusions of little value (read: misleading!). They are as follows:

The study assumed the market timing investor would be sophisticated enough to initially invest in mutual funds, but at the same time be so unsophisticated that he or she would not put cash contributions into an interest-bearing money market account. Frankly, anyone who is that unsophisticated is probably hiding money in their mattress or burying it in jars in their back yard, not investing in buy-and-hold mutual fund programs.

So, what would adding interest do to the market timing total? To find out, I consulted the Morningstar mutual fund database and obtained the average returns for the taxable money market category for the time period in question. If we assume that only the ongoing contributions were diverted to cash and the accumulated balance stayed in the stock market, the interest on the $500 monthly contributions would increase the total value to $34,074, beating the buy-and-hold ending value of $33,502 by $572.
The next flawed assumption is even more important. The fund company study assumed that only the ongoing $500 per month contributions would be “timed,” or put in a cash account, while the entire accumulated balance would continue to be subject to the whims of the market. In all my years of advising clients and evaluating active money managers, I have never seen anyone time the market like that.

The reality of the situation is someone nervous about investment losses would most likely move their largest balance to the safety of cash, and not just the ongoing monthly contributions. Thus, it is ridiculous to assume that only the ongoing contributions would be made to cash.

If we adjust the calculations to assume both the ongoing contributions and the accumulated balance are taken to cash in April of 2000, we get a much different picture. Assuming the Bear Market Dodger moved the entire account out of the market in April of 2000 and then back in again in January of 2004, he ended up with a value of $37,373 at the end of January 2004, as opposed to the study's buy-and-hold calculation of $33,502. That's a difference of over $3,800 in favor of the market timer.
The original study also assumed that a market timer would have missed out on all of the market gains in 2003. That assumption is questionable, at best. However, I'm not going to try to illustrate moving back into the market earlier than assumed in the study, since doing so would simply be a guess based on 20/20 hindsight. However, I can say that our experience with the professional active managers we recommend is that most participated in at least part of the market rally in 2003.

For example, the Potomac Guardian program that I will highlight below was fully invested in the market as early as November of 2002, just as the market was showing renewed signs of life. As a result, Potomac participated in the entire 2003 market rally and gained over 21% that year, net of all fees and expenses. While there's no guarantee that Potomac can always make such timely calls, this underscores what I always say about knowing when to get back in the market is more important than knowing when to get out. Plus, it blows another hole in the buy-and-hold study.
Another problem is that the study projected values 30 years into the future, starting in 2004, to show the long-term effect of “bad timing.” While I'm tempted to run our revised Bear Market Dodger numbers out that far using their assumptions, doing so would be irresponsible, especially using the 10.2% long-term average total return of the S&P 500 from 1927 to August of 2008 quoted in the study.

I hate to tell the folks who produced this study, but they are already way behind. The annualized return of the S&P 500 Index for the five years from 2004 through 2008 is a negative 2.19%. That means the market will have to do substantially better than 10.2% over the remaining 25 years of their projection period to keep up with their study's conclusions. It's possible, but it's not probable.
And speaking of being behind, the study was published in September of 2008, well after the official declaration of a new bear market in stocks that began in October of 2007. Even worse, the IBD article came out in February of 2009, long after the bear market accelerated its losses in the fourth quarter of 2008. Why was performance after January of 2004 disregarded in the study? I think we all know the answer to that question.

Unfortunately, I'm sure that many investors who read the IBD article or reviewed the fund study didn't pick up on the flawed assumptions designed to favor buy-and-hold, especially when it was published by a trusted name in the financial media. The moral to this story is that you should read any comparison of investment strategies with great care, even if they come from what most consider to be reliable sources.

And one final point on the study. As noted above, the market timing strategies in the study were not real market timing strategies, but rather just completely hypothetical scenarios dreamed up by the mutual fund company. In each strategy, the decision to get out of the market was based on fear and emotion. The successful market timers I recommend do not operate out of fear; instead, they have very sophisticated systems that generate trading signals.

Another Active Manager Doing It Right

In light of the blatantly skewed materials being produced by huge mutual fund firms and lovingly embraced by the financial media, I want to provide some straight talk about a money manager I have mentioned many times over the years in these pages, and have been recommending for over a decade. Specifically, I'm going to bring you up to date on the Potomac Fund Management Guardian Program.

We got a lot of good feedback from readers in regard to my January 27 E-Letter in which I highlighted Niemann Capital Management and Scotia Partners, so I'm going to follow the same format in the discussion below. As I did with Niemann, the Potomac Guardian Program will be evaluated over a 10-year period ending as of 12/31/2008. As always, I'll also provide a link to the complete strategy description and detailed track record of this program.

Also note that the Potomac Guardian managed account makes up just a part of the professionally managed investments we recommend as part of our AdvisorLink® Program. More information about these strategies and their performance can be found on our website, along with detailed descriptions of each strategy. Just click on the following link to see performance information on all of the various actively managed investments we recommend within our AdvisorLink® Program.

Potomac Guardian – Slow And Steady

The objective of the Potomac Guardian program is to participate in stock market growth while also limiting portfolio volatility and risk of extensive loss. Note that Guardian is a long or neutral (cash or hedged) only program, and does not seek to take net short positions in order to gain during down markets.

Guardian seeks to achieve this objective by allocating portfolios across many sectors and/or asset classes, over-weighting those identified by its model as having the best risk-to-reward ratio. Investments are primarily limited to low-volatility mutual funds in an overall effort to reduce downside exposure. In down markets, Guardian will shift to cash or hedged positions to gain a neutral exposure to the markets.

Looking at the turbulent markets in 2008, it appears that Potomac met its objective of limiting losses in down markets. In a year when the S&P 500 Index and Dow Jones Industrial Average both lost over 30% of their value, the Potomac Guardian program limited portfolio losses to only 11.68% in 2008, net of all fees and expenses. Of course, past performance is not necessarily indicative of future results.

However, the real value of the Potomac Guardian program becomes more apparent when you compare its performance to that of the alternatives in the marketplace over a 10-year period. Therefore, as I did with the Niemann Equity Plus program in my January 27 E-Letter, this week we'll see how the Potomac Guardian program did when compared to the entire universe of stock and bond mutual funds.

The Analysis

I had my staff run some mutual fund searches on our Morningstar Principia software using performance data as of the end of December of 2008 with the Potomac Guardian program as a baseline. I eliminated mutual funds with super-high minimum investments available only to institutional investors. I also restricted the search to Morningstar's “Distinct Portfolios,” which eliminates multiple share classes for the same fund.

We then searched for mutual funds with 10-year average annualized returns greater than Guardian's 6.00%, net of all fees and expenses. According to Morningstar, there were over 300 such funds in existence out of a total universe of more than 7,700 mutual fund “Distinct Portfolios.” Already, Guardian is better than 95% of mutual fund alternatives.

However, return alone is not all we're looking for. Risk management is a big part of what Potomac offers, since it will move to cash or hedged positions during down markets. As you know, we use “peak-to-valley drawdown” as one way to determine an investment's overall risk. However, Morningstar does not provide drawdown information on mutual funds. Therefore, I used Guardian's 2008 performance of -11.68% as a proxy for drawdown in our Principia search.

Using the additional 2008 performance criterion, we found that there were a total of 27 mutual funds that could boast a 10-year annualized return greater than Guardian's 6.00%, while also keeping losses to less than -11.68% in 2008. Past results do not guarantee future performance.

However, we weren't done yet. Recall that we use drawdown as a risk-analysis measure in all of our programs. Now that we had narrowed down the universe of mutual funds to a just a few candidates, we used another of our mutual fund analysis tools to obtain the maximum drawdown of the 27 mutual funds with a higher 10-year annualized return than Guardian. We found that only 12 funds beat Potomac Guardian's 10-year performance AND limited their drawdowns to under Potomac's -15.79% worst peak-to-valley performance.

However, none of the funds that beat Potomac's 10-year returns were equity mutual funds. In other words, Potomac's 6.00% annualized return beat every equity “distinct portfolio” in the Morningstar database. Of the mutual funds that did perform better than the Guardian program over the last decade, most were government bond funds.

With the current credit crunch and uncertain bond markets, many analysts are doubting whether even government bonds can repeat this type of performance, especially in light of the Treasury's having to print money to cover trillion-dollar bailouts. Thus, when considering 10-year annualized returns, 2008 calendar-year performance and maximum drawdowns, the Potomac Guardian Program beat all equity mutual funds in the Morningstar database. Now that's impressive long-term performance. Past performance, however, is not a guarantee of future results.

While other time periods will likely render different results, I believe the 10-year time window is important, especially for actively managed investment programs, because it encompasses two different cyclical bear markets. While no one knows what the future holds, the ability to deliver a consistent gain over 10 years, coupled with holding drawdowns to -15.79% or less is just the kind of performance we have come to expect from Potomac Fund Management.

Potomac has the distinction of having the longest tenure on our list of recommended professional money managers. The Potomac Guardian Program has been a mainstay of our AdvisorLink® Program since its inception in June of 1996. Over that time, it has produced an annualized return of 8.96% as of the end of January, 2009. As always, there are no guarantees for the future.

As noted above, Potomac has been able to produce these returns by utilizing its ability to move to cash or hedge long positions in downward markets. Yet the critics, armed with flawed studies like the one recently highlighted by IBD, still say that “market timing” doesn't work. Well, yes it does if you can find a successful manager like Potomac, Niemann or our other AdvisorLink® money managers.

For more information on the Potomac Guardian Program and performance, please click on the following link to access our Potomac Guardian Advisor Profile. If you would like for us to send you an Investor Kit on this program that contains the Advisor Profile plus documents necessary to establish an account, just click on the link for our Potomac online request form, or give one of our Investment Consultants a call at 800-348-3601.

Be sure to read all of the Important Notes and disclosures that follow my signature at the end of this E-Letter in regard to the above performance statistics. Also, keep in mind that the universe of mutual funds on the Morningstar database consists of a wide variety of different types of funds and strategies, many of which are different from those utilized by Potomac.

Conclusions

I know that this week's E-Letter covers a lot of ground. To summarize, I'd like you to take a few key points away with you now that you've read it. First, the markets are in bad shape and have resisted every attempt to prop them up. While many analysts have indicated that we have hit “the bottom” since the end of 2008, the market continues to perform as if it had a mind of its own, indifferent to the experts' opinions. As this is being written, the Dow has dipped below 6800 for the first time since April of 1997. Will this be the bottom? It might, but it also might not.

Next, no matter how poorly the market performs, those with vested interests in you keeping your money in the market will produce “studies” and other authoritative sounding materials to keep you invested in their products. Some, as the one discussed above, will be based on flawed assumptions, and worst of all, they will sometimes be embraced by trusted members of the financial media. If you learn nothing else from this article, please take away with you that you should always approach any such financial industry study with a critical eye, asking yourself whether the assumptions used make sense in today's world.

Last but not least, no matter how many studies try to disprove the benefit of active management, there are professional money managers who have successfully employed these strategies for well over a decade. To ignore the actual historical track records of these managers is to rob your portfolio of an additional source of diversification.

In closing, one of my staff members recently gave me an article authored by Steve H. Hanke, a professor of applied economics at the Johns Hopkins University and a senior fellow at the Cato Institute. He notes that “Following conventional wisdom has led an entire generation of investors down the road to ruin.” I agree, yet we still see official-looking studies like the one discussed above that continue to spout conventional wisdom as the way out of the abyss.

Truth be known, it might be that had many investors not followed conventional wisdom, they wouldn't be in the abyss in the first place. I think it's time that you consider being a little unconventional in your approach to investing. I and my staff stand ready to help you shed the confines of conventional wisdom and experience active management for yourself. Just give us a call at 800-348-3601 or send us an e-mail at info@halbertwealth.com.

Wishing you profits,

Gary D. Halbert

SPECIAL ARTICLES:

Stocks Drop to 50% of Peak (subscription may be required)
http://online.wsj.com/article/SB123543520857454281.html?mod=todays_us_nonsub_page_one

When Buy-And-Hold Beats Bad Timing (subscription may be required)
http://www.investors.com/editorial/IBDArticles.asp?artsec=19&issue=20090217

IMPORTANT NOTES: Halbert Wealth Management, Inc. (HWM) and Potomac Fund management (PFM) are Investment Advisors registered with the SEC and/or their respective states. Some Advisors are not available in all states, and this report does not constitute a solicitation to residents of such states. Information in this report is taken from sources believed reliable but its accuracy cannot be guaranteed. Any opinions stated are intended as general observations, not specific or personal investment advice. Please consult a competent professional and the appropriate disclosure documents before making any investment decisions. HWM receives compensation from PFM in exchange for introducing client accounts. For more information on HWM or PFM, please consult the appropriate Form ADV Part II, or the PFM Annual GIPS Disclosure Presentation 2007, available at no charge upon request. Any offer or solicitation can only be made by way of the Form ADV Part II. Officers, employees, and affiliates of HWM may have investments managed by the Advisors discussed herein or others.

As benchmarks for comparison, the Standard & Poor's 500 Stock Index (which includes dividends) and the NASDAQ Composite Index represent unmanaged, passive buy-and-hold approaches. The volatility and investment characteristics of the S&P 500 or the NASDAQ Composite may differ materially (more or less) from that of the Advisor, and these Indexes cannot be invested in directly. The performance of the S & P 500 Stock Index and the NASDAQ Composite is not meant to imply that investors should consider an investment in the Potomac Guardian trading program as comparable to an investment in the “blue chip” stocks that comprise the S&P 500 Stock Index or the stocks listed on The NASDAQ Stock Market that comprise the NASDAQ Composite.

Potomac's performance results are based on the Model Portfolio. The Model Portfolio is an actual account that is considered representative of the majority of client accounts with similar investment objectives. Returns for the Model Portfolio are time-weighted, total returns that reflect the reinvestment of dividends and capital gain distributions. The Guardian strategy is actively allocated across many sectors and/or asset classes, overweighting those exhibiting the best risk-to-reward ratio. Statistics for “Worst Drawdown” are calculated as of month-end. Drawdowns within a month may have been greater. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Any investment in a mutual fund carries the risk of loss. Mutual funds carry their own expenses which are outlined in the fund's prospectus. An account with any Advisor is not a bank account and is not guaranteed by FDIC or any other governmental agency.

When reviewing past performance records, it is important to note that different accounts, even though they are traded pursuant to the same strategy, can have varying results. The reasons for this include: i) the period of time in which the accounts are active; ii) the timing of contributions and withdrawals; iii) the account size; iv) the minimum investment requirements and/or withdrawal restrictions; and v) the rate of brokerage commissions and transaction fees charged to an account. There can be no assurance that an account opened by any person will achieve performance returns similar to those provided herein for accounts traded pursuant to the Potomac Guardian trading program. Comparisons to the universe of mutual funds in Morningstar is not meant to imply that an investment in Potomac Guardian is comparable to each or any of these different mutual funds, most of which have different strategies and investments than those used by Potomac's Guardian program. The comparison is made for informational purposes only.

In addition, you should be aware that (i) the Potomac Guardian trading program is speculative and involves a moderate degree of risk; (ii) the Potomac Guardian trading program's performance may be volatile; (iii) an investor could lose all or a substantial amount of his or her investment in the program; (iv) PFM will have trading authority over an investor's account and the use of a single advisor could mean lack of diversification and consequently higher risk; and (v) the Potomac Guardian trading program's fees and expenses (if any) will reduce an investor's trading profits, or increase any trading losses. Returns illustrated are net of the maximum management fees, custodial fees, underlying mutual fund management fees, and other fund expenses such as 12b-1 fees. They do not include the effect of annual IRA fees or mutual fund sales charges, if applicable. No adjustment has been made for income tax liability. Money market funds are not bank accounts, do not carry deposit insurance, and do involve risk of loss. The results shown are for a limited time period and may not be representative of the results that would be achieved over a full market cycle or in different economic and market environments.

Retirement Focus - Year-End Retirement Sugarplums

Gary D. Halbert — Tue, 16 Dec 2008 20:27:04 GMT

by Mike Posey

IN THIS ISSUE:

Mandatory IRA Distributions
IRA Charitable Contributions
Roth Conversions
Max Out Retirement Contributions
Plan Your 2009 Investment Strategy

Introduction

The Christmas season is upon us and the end of 2008 will be here before we know it. At this time of year, many people "coast" for the rest of the year, enjoying the holidays and using those vacation days before they are lost at the end of the year. Actually, coasting is probably not the most appropriate term, since it seems that the holidays are sometimes busier than even our toughest work schedule.

However, the end of the year is also a very busy time for retirement planning, both for those who provide plan and investment services, as well as for sponsors and participants. This is especially true this year due to the bear market having decimated many retirement portfolios. Not only do smaller nest eggs sometimes require special year-end planning, but there have also been calls for the Treasury to waive certain requirements related to retirement distributions.

Specifically, some members of Congress and even AARP have joined together to request that the minimum distribution requirements applicable to taxpayers over the age of 70½ be frozen for 2008 due to the hit most IRAs and other defined contribution plans have taken in the market this year. This may or may not be a good idea, depending upon your circumstances, but no matter what form it may take, you need to be prepared to take appropriate action if you have not already done so.

This week, I'll discuss the proposal to waive the minimum distribution rules, as well as discuss what to do if they are not waived. I'll also toss in a number of other retirement sugarplums to dance in your heads before kicking back for what's left of 2008.

Mandatory IRA Distributions

As I mentioned above, various members of Congress and other interested groups have requested that Congress and/or Treasury Secretary Paulson waive the rules that require minimum annual distributions be made to taxpayers age 70½ or older from IRAs and certain other types of defined contribution retirement accounts. The Required Minimum Distribution (RMD) rule exists, by the way, to insure that these retirement plans do not postpone payment of taxes on accumulated balances in perpetuity.

Since there are some account holders who may not ever need to access this money for retirement income purposes, the IRS requires that a certain portion be liquidated each year, beginning in the year in which the account holder turns age 70½. The payout is calculated based on a formula that liquidates the entire account over the estimated remaining lifetime of the individual.

However, one small glitch in the calculation is that the distribution for 2008 would be based on the accumulated value as of 12/31/2007. Since most retirement accounts hold stocks, bonds and/or mutual funds, there's a very good chance that the account value is FAR LESS now than it was at the beginning of the year. Thus, unless the rule is modified in some way, the percentage of the account required to be liquidated would be much larger than if the current value were to be used.

Various proposals have been floated to address the situation, ranging from allowing the current value to be used for the calculation to waiving the RMD rule entirely for a period of time. Financial industry experts have been somewhat divided on waiving the RMD rule. Some say that cashing out shares of stocks or mutual funds at a depreciated value locks in losses and eliminates any chance to participate in any market rebound we might see in the future.

Others, however, say this provision would primarily help those wealthy enough to take only minimum distributions from their Traditional IRAs. And let's not forget that any modification of the RMD rules would also affect income tax revenues. Maintaining the RMD rule for 2008 would be best from a Treasury tax revenue standpoint since the 12/31/2007 cumulative IRA account values are likely much larger than they are now.

To address the growing chorus of organizations calling for RMD relief, the House and Senate have recently passed the Worker, Retiree and Employer Recovery Act of 2008 (HR7327). Among other things, this bill contains a provision that would suspend the RMD rules for 2009 (but not 2008!!!). The bill is now headed to President Bush and he is expected to sign it.

It is unfortunate that the bill did nothing to help those who are required to take 2008 RMDs, which are still required by December 31st (or April 1st, if you just turned 70½ in 2008). If you fail to take the RMD, you will be subject to a penalty tax of 50% of the amount that should have been withdrawn. Therefore, do NOT assume that passage of this bill relieves you from having to take a RMD for 2008 – it doesn't.

As a practical matter this bill is like most political solutions – long on form and short on substance. While politicians can hold press conferences and brag that they are helping senior citizens, they failed to address the key issue of having to sell depreciated assets for this tax year. As a bonus, the politicians also get to reap the benefits of tax revenues based on substantially higher values than retirees now enjoy. What else is new?

Importantly, you may still be able to minimize the effects of having to sell assets at a loss by requesting your IRA or 401(k) plan trustee or custodian to do what's known as an "in-kind" distribution. This means that the custodian transfers stock or mutual fund shares to you rather than cashing them out and sending you a check. You still have to take an equivalent amount of shares to equal the distribution required by the 12/31/2007 value and pay tax on this amount, but you will still hold the shares in case of a possible rebound in value in the future.

Even better, you can usually direct the custodian or trustee as to which investments you want to take as a distribution. For long-term income tax planning, you might want to transfer shares in 2008 that you feel may have a higher potential for future gain and leave others in the IRA for subsequent required distributions. The thinking is that identifying investments with greater gain potential may result in lower future income taxes, assuming long-term capital gains tax rates remain considerably lower than ordinary income tax rates in the future. Just be sure to talk to your tax professional and/or financial advisor if you have questions about which assets to take as an in-kind distribution.

Charitable Donations From An IRA

Earlier this year, Congress passed legislation that allows individuals age 70½ or older to make a one-time transfer of up to $100,000 from an IRA to a qualified charity. While IRA account holders do not get a tax deduction for the gift, they also do not have to claim the IRA distribution as income. Thus, for someone who does not need their IRA for retirement income purposes, this allowance permits them to use up to $100,000 of it to benefit the charity of their choice.

Admittedly, this provision applies to a very small segment of the population, but those who can take advantage of this opportunity find that it can be an integral part of their estate and gift planning. Since IRAs are often subject to both estate and income taxes at death, the ability to make what amounts to a pre-tax contribution can be very attractive.

Also note that it may be beneficial to make a transfer this year while the IRA value is down due to the bear market. Making an in-kind rollover contribution to a charity may potentially result in a much bigger bang for the buck on behalf of your favorite charity should the market experience a rebound in the near future.

While charitable IRA rollovers have been extended through December 31, 2009, you need to move quickly if you want to make such a contribution effective for 2008. Since you must involve your IRA trustee or custodian in the transaction, time is of the essence. Fortunately, many major charities and IRA custodians are familiar with processing these transactions and can provide their help to expedite the transaction.

Roth IRA Conversions

If you have a traditional IRA, retirement distributions will generally be subject to ordinary income tax in the year in which you take the money. The conventional wisdom used to be that retirees would be in a lower tax bracket than they were in during their working years, so tax deferral was always beneficial. However, as this is written, current tax rates are among the lowest we've ever seen, so it is no longer a given that future tax rates applicable to retirees are likely to be lower (especially with the Democrats in control of the White House and Congress).

Back in 1997, the Roth IRA was introduced to offer an alternative to taxpayers who wanted to save for retirement. Without going into full detail, Roth IRAs differed from traditional IRAs in that contributions to the Roth IRA would not be deductible from current income, but if held for a minimum period of time, all earnings would escape future taxation.

Individuals with traditional IRAs were also given the option to convert their existing IRAs to Roth IRAs under certain conditions. Roth IRA conversions are currently available only to IRA account holders whose modified adjusted gross income (MAGI) is less than $100,000. While not everyone with a traditional IRA can benefit from a conversion, they can be beneficial if the right set of circumstances exist.

The conversion process involves deciding whether conversion makes sense for you, working with your IRA trustee or custodian and then paying income tax on the amount converted. While taxes are currently due, there is no 10% penalty tax applied if you convert your traditional IRA to a Roth IRA before age 59½. You will need to contact your IRA trustee or custodian to determine the exact process you must go through to effect a conversion.

Depending upon the size of the traditional IRA, the taxes due can be quite a large sum. However, if you believe that tax rates are lower now than they may be in the future during your retirement, then it may make sense to make the conversion. This is especially true this year, since the bear market has reduced the value of many traditional IRAs, thus reducing the income taxes that would be due upon conversion of the entire account.

The details of the decision process of whether or not to convert a traditional IRA to a Roth IRA is one that involves a number of factors that are beyond the scope of this section of the E-Letter. But as a general rule, Roth IRAs are more beneficial for younger investors who have lots of time for tax-free earnings to grow. Even so, a conversion can also be beneficial for older IRA account holders in certain situations.

The potential advantages of converting your traditional IRA to a Roth IRA include the following:

A Roth IRA of the same size as a regular IRA actually has a greater economic value since distributions will not be reduced by income taxes;
There is no requirement that minimum distributions begin at age 70½ as is the case with a traditional IRA;
Roth IRAs remove the risk of higher future tax rates, since amounts can be withdrawn tax-free in retirement;
Partial conversions can be done if the taxpayer does not have enough money from other sources to pay the income taxes necessary upon a full conversion; and
Roth IRAs can also simplify estate planning since the balance of a Roth IRA transferred to an heir will not be subject to income taxes, though it may be subject to estate taxes.

There are, however, potential disadvantages of making the conversion to a Roth IRA, including:

It is possible that future tax rates could be lower than current tax rates, though I doubt it;
The amount of tax due upon conversion can be considerable, and could push the account holder into a higher tax bracket. Plus, some IRA account holders cannot pay the taxes on a full conversion from other resources and resort to withdrawing money from the IRA to pay the tax, possibly subjecting themselves to a 10% penalty tax if they are under age 59½. In both of these situations, it is sometimes better to do a partial conversion to minimize these disadvantages;
State income tax issues can also sometimes come into play when making a Roth IRA conversion;
Older traditional IRA account holders may not have enough time prior to retirement to make up the current taxes that must be paid on the conversion; and
The taxation upon conversion is determined by the value of the account at the time of conversion. Thus, if the value drops later on in the year, like we saw in October and November of this year, the taxes due can be a much larger share of the year-end traditional IRA value than they were at the date of conversion (more about this later on).

If it appears that making the conversion would be beneficial for you, then doing so before the end of 2008 may reduce the taxes due upon conversion due to the effects of the bear market. However, time is short as the money must be removed from your traditional IRA before the end of the year to be effective. Fortunately, you do have until after the end of the year to place the money into the new Roth IRA, but the process must begin before the end of this month.

I mentioned above that one of the disadvantages of conversion is that if you converted a traditional IRA to a Roth IRA earlier in 2008, the taxes due will be based on the value at the time of conversion. However, we all know that many IRAs have experienced large losses in October and November of this year. Thus, the taxes due on an early 2008 conversion will likely be much larger than if they had been calculated based on the December value of the IRA.

Fortunately, there is a way to fix this, but it involves a bit of paperwork. The rules allow for a Roth IRA "recharacterization" in which the Roth IRA is converted back to a traditional IRA, thus eliminating the income taxes due upon conversion. This recharacterization can be done any time up to the tax return due date, including extensions, so you effectively have until October of 2009 to "undo" the transaction.

Oh, and for those of you thinking ahead and considering recharacterizing a prior Roth conversion and then immediately converting the IRA again at a lower value, the IRS is one step ahead of you. The conversion rules provide that if you recharacterize an IRA conversion, you have to wait until the next tax year to do another conversion.

Again, this has been just a very brief discussion of the conversion and recharacterization process. The final decision must be based on all the tax and other consequences applicable to your individual situation. Thus, it is imperative that you consult a qualified tax professional or financial advisor prior to taking any action in regard to the conversion process.

Max Out 401(k) contributions

While it is very late in the year, you may also want to consider maxing out your 401(k) contributions. Many employer plans allow for very high contribution percentages, which can be used to increase the amount of your 2008 pre-tax 401(k) contributions here at the end of the year. You will need to consult with your Human Resources Department to determine how much you can contribute and when your payroll request must be submitted, but if you can afford the extra deduction, it's a good way to "top-off" your 401(k).

The same idea can apply to year-end bonuses paid on or before December 31st. Many employer 401(k) plans allow employees to elect whether or not to include or exclude bonuses from the 401(k) contribution election. However, you may also be able to contribute a larger percentage of your bonus to your 401(k). This not only increases the amount of pre-tax contribution for 2008, but may also increase your employer matching contribution, depending upon the specific provisions of your plan.

Now is also a good time to make any adjustments in your payroll deduction for next year. The maximum 401(k) employee contribution has been increased from $15,500 to $16,500 for 2009. In addition, the "catch-up" contribution limit for participants age 50 or older has increased from $5,000 to $5,500 for 2009. You may want to increase your applicable contribution percentage to take advantage of these new limits.

In addition, it is important to note that payroll systems usually do not recognize employees age 50 or over and allow catch-up contributions. For example, let's say you are over age 50 and have a contribution percentage that allows you to reach the $16,500 maximum contribution level in September of 2009. If you want to continue your contributions after that under the catch-up contribution rule, you may need to take additional action.

Check with your Human Resources Department to see if your employer's payroll system will automatically recognize that you are eligible to contribute an additional $5,500 due to your age, or if it will require you to set up a separate catch-up contribution deduction. I suspect that most payroll systems require you to make an additional election in order to take advantage of the catch-up contribution.

Plan Your Investment Strategy

One of the most frequent questions we get from 401(k) participants is when they should get back into the market. It's a very good question, and we're always happy to hear that some participants elected to move to cash, thus escaping some of the carnage we've seen in the market. However, there may still be a lot of risk of being in the market, so the decision of whether to stay in cash or get back into the market is a hard one, even for those of us in the investment business who participate in our employers' 401(k) plans.

For investors with IRAs or personal investment portfolios that are now largely in cash, we offer a number of risk-managed alternatives that have the ability to go to cash or hedged positions, or even go short in an effort to minimize the effects of uncertain markets. In many 401(k) plans, however, choices are limited to a variety of mutual funds that may or may not incorporate active management techniques to control risk.

While it is not possible to provide investment advice without knowing the specific situation of the investor, there are some very general rules that may be helpful to you in your 401(k) investing at a time like this when the market is extremely volatile and advice from the talking heads on financial shows seems to go in all different directions.

What 401(k) investors want to know when they call us is whether it is safe to invest in the stock market again, essentially asking if we've hit "the bottom" and prices will rise from this point on. While there have been some notable financial gurus saying that the market has reached the bottom and it's poised for a rebound, no one can know this for certain. The only predictable thing about the subprime crisis and resulting bear market has been their unpredictability.

The subprime contagion has spread to different sectors of the global economy over time, so no one really knows whether we have seen the final effects, or whether there's more to come. The uncertainty currently gripping the stock market has made it emotionally difficult for many 401(k) participants to direct the investment of their accounts. They hear advice saying to buy in when the market is low in order to maximize future returns, but then hear other "experts" say that the US is headed for another Great Depression.

The only thing we do know is that the market is nearer the bottom now than it was earlier this year, and certainly a better buy than when it hit new record highs in October of 2007. However, buying in now could lead to losses should the market fall further in the future. So how should you invest your 401(k) money in such a situation?

If you have a large cash or fixed-income investment position in your 401(k) plan, one answer to this question may be to consider using a technique called "dollar cost averaging" (DCA). In a nutshell, dollar cost averaging means to invest money in increments over time rather than doing it in one lump sum. The premise is that you purchase shares at different price levels over time, so you worry less about whether you're buying in at the bottom or not.

In essence, you are already using DCA in your 401(k) since your monthly contributions buy shares of investments at different prices during your employment. While using DCA to invest a large cash balance requires more of your personal involvement than do regular monthly contributions, it can also relieve some of the emotional stress from trying to guess when we hit "the bottom" in the stock market.

The amount of your cash reserve that is invested and the timing of those investments are variables that you control. Some investors may be comfortable with only moving 10% of the cash position into investments at any given time, while others may want to do much more. The timing can be every month, every quarter or even just whenever you feel comfortable in making another investment. The important thing is that timing "the bottom" becomes less important as your average share cost reflects a variety of price levels.

I would be remiss if I didn't mention that studies have been published which indicate investing a lump sum all at one time can lead to higher eventual returns than using DCA to gradually enter the market. Since I have not studied the detailed methodology behind each of these studies, I can't comment on their validity, but I did want to mention that not all brokers and financial advisors agree with using DCA (especially those who get paid only as the money is invested).

Since it's impossible to tell whether future market conditions will be similar to those covered in the studies mentioned above, I think it's also important to focus on the emotional issues that are addressed by DCA. If you can be comfortable with averaging your cash position into the market, this may be better than agonizing over when to pull the trigger and invest a lump sum.

In fact, we sometimes see 401(k) participants who simply can't decide when to invest a large cash position, so they remain on the sidelines even after the market begins to rebound. By the time they finally decide, the bull market rally is in full force, and they may have missed out on much of the market's rebound.

Again, dollar cost averaging is an investment strategy that may or may not fit your investment goals or risk tolerance, but it is one you can consider as we continue to watch the market's large up and down swings. If you would like to learn more about using this technique to ease back into the stock market, give one of our Investment Consultants a call at 800-348-3601 or send us an e-mail at info@halbertwealth.com. We'll be happy to help you.

Conclusions and Happy Holidays

Since I won't likely be writing another Retirement Focus issue prior to the end of the year, I'd like to take this opportunity to thank all of you who have been regular readers during the year, and especially those who have contributed comments and suggestions along the way. This feedback helps me to target the retirement issues that are of most concern.

As we look forward to 2009, it's almost certain that we will see additional legislation and regulatory changes as the federal government seeks to mitigate the effects of the credit crunch and resulting bear market. As new pronouncements are made, I will do my best to bring them to your attention so that you can take advantage of those that apply to your financial situation.

In the meantime, I hope you have the merriest of Christmases, or whichever holiday you may be celebrating, and a safe and happy New Year.

P.S. - From Gary

I would like to thank Mike for all the very good information he provides to all of us in his periodic Retirement Focus issues. With his background as the former president of a large trust company, he is certainly better qualified to understand and explain these often complicated retirement account issues than am I.

In addition to all the good information Mike provides, it also gives me a much-needed break from writing every so often. So, I also thank him for that!

With Warmest Holiday Wishes,

Mike Posey

SPECIAL ARTICLES

How We All Will End The Recession
http://www.forbes.com/opinions/2008/12/15/recession-catalyst-recovery-oped-cx_bw_rs_1216wesburystein.html

5 Myths About Our Sputtering Economy
http://www.washingtonpost.com/wp-dyn/content/article/2008/12/12/AR2008121203364_2.html

Five Opportunities to Help Beat World Recession
http://www.bloomberg.com/apps/news?pid=20601039&sid=aS98ereBggE8&refer=columnist_lynn

"Gifting" & Things To Be Thankful For This Holiday

Gary D. Halbert — Tue, 25 Nov 2008 19:56:05 GMT

IN THIS ISSUE:

Gifting To Those You Love
Gifting: Control Is The Issue
A Good WayTo Gift, In My Opinion
A Time To Give Thanks

Introduction

As we near the end of November, the current economic and stock market situation may make giving thanks the last thing that enters our minds. However, even with all of the negatives we have encountered in 2008, we still live in the greatest country in the world, and one that offers as much promise and opportunity as ever.

It is therefore with confidence that I write this Thanksgiving week E-Letter that encourages you to seek out those people and things that you can be thankful for. As the market has shown us, wealth can be fleeting, but our families, friendships and faith can always be sources of gratitude, no matter what kind of mess the world is in.

Also, since we're entering the season of giving, I want to revisit the issue of "gifting" and how you can give up to $12,000 per year to your kids or grandkids (or anyone for that matter) with no tax consequences. A husband and wife can give $12,000 each, or a total of $24,000 a year, to each child or grandchild with no tax consequences for the donors or the recipient(s).

Gifting is one good and legal way to minimize estate taxes. You can transfer large sums of money to your kids or grandkids (or whomever) by taking advantage of gifting. Of course, there are smart ways to do this, and there are not-so-smart ways to do this. You need to be careful in how you take advantage of the "gift tax exclusion."

The point is, this is the time of year to consider the smart ways of gifting to those that you love. I will discuss this in more detail in the pages that follow.

And given that this is the week of Thanksgiving, I will tell you what I am particularly thankful for this year. Let's get started.

Gifting To Those You Love

Let me start this discussion with a quick bit of background. Being in the investment management business, we get questions every year from clients and prospective clients who are trying to help their kids or grandkids learn to save and invest wisely. One of the most common observations along this line is: "I would really like to help my kids with investing, but they just don't have enough money to get started."

This is all too true. Most young families just make ends meet and don't have the savings to start an investment program when they really need to. Along that line, another very common comment we hear is: "I would love to give them the money to get started, but I worry they would just blow the money on wasteful things."

Yet there are ways to gift money to your kids or grandkids that are not only earmarked for certain financial expenditures (college, medical, etc.), but can be targeted for investments that will serve them well later in life. And there are ways you can increase the odds that money you gift to your kids or grandkids will be used for the purposes you desire.

I will talk more about that below, but first let's explore the basics of the gift tax exclusion. Current tax law allows you to gift up to $12,000 per year to a child, grandchild, or anyone, with no tax consequences to either the donor or the recipient. As noted above, a husband and wife can give $12,000 each, or a total of $24,000 a year, to an individual in 2008 with no tax consequences for the donor(s) or recipient(s). The gift tax exclusion is indexed to inflation, and the IRS has recently announced that it will be increased to $13,000 for 2009.

The annual gift tax exclusion is one of the most popular ways that individuals have to transfer a portion of their estates to their heirs over the years prior to their deaths, thus reducing the significant estate taxes their heirs will have to pay. Gifting has the double benefit of helping those you love and reducing estate taxes that go to the government.

I'm surprised that more families don't take advantage of the gift tax exclusion. My wife, Debi, and I gift the maximum to our two kids - currently $12,000 per parent or $24,000 a year to each kid. We gift this money each year into trusts that we have set up for each of our kids.

Gifting: Control Is The Issue

One of the requirements of the gift tax exclusion is that the beneficiary must have ownership and control of the assets donated. This is a big deal when considering gifting $12,000-$24,000 (perhaps annually) to a child, grandchild or other person(s). Generally speaking, if you gift it, the money becomes theirs, and it is possible that they can just blow the money on wasteful spending if they want.

This is one reason why many people do not elect to take advantage of the gift tax exclusion, as far as I can tell in talking to estate tax attorneys. But there are ways - directly and indirectly - to effect control of the assets gifted to a child or grandchild. If the child is a minor, the gifts can be made to a trust which can designate what the money may be spent for, such as college, medical expenses or whatever.

As noted above, Debi and I have established trusts for each of our children, and these trusts are where we make our annual contributions. Trust laws vary among the states, so I won't get into what type of trusts may be best in your particular situation, but this can be a very good way to transfer assets to minor children and maintain control over those assets, at least until they reach legal age, or whatever age you specify in the trust(s).

In some states, minors do not have the right to execute a contract, and thus cannot own stocks, bonds, mutual funds, annuities and life insurance policies in their names. In such cases, parents cannot simply transfer assets directly to their minor children, but instead must transfer the assets to a trust. The trust(s) can be a private trust you establish for your kid(s) with the help of an attorney, or a custodial account such as a UGMA or UTMA account, both of which can hold securities.

The Uniform Gift to Minors Act (UGMA) established a simple way for a minor to own securities without requiring the services of an attorney to prepare trust documents or the court appointment of a trustee. The terms of UGMAs are established by state statute instead of a trust document. The Uniform Transfer to Minors Act (UTMA) is similar, but also allows minors to own other types of property, such as real estate, fine art, patents and royalties, and for the transfers to occur through inheritance. The UTMA is slightly more flexible than the UGMA.

To establish a custodial account, the donor must appoint a custodian (trustee) and provide the name and social security number of the minor. The donor irrevocably gifts the money to the trust. The money then belongs to the minor but is controlled by the custodian until the minor reaches the age of trust termination. The age of trust termination is 18 to 21, depending on the state and whether it is an UGMA or an UTMA. Most UGMAs end at 18 and most UTMAs at 21, but it does depend on the state. The custodian has the fiduciary responsibility to manage the money in a prudent fashion for the benefit of the minor. Custodial accounts are most often established at banks and brokerages.

The bottom line is that gifting is a great way to transfer assets to those you love without tax consequences. But there must be a high degree of trust involved. If you do elect to form trusts, be sure to consult with an attorney that is familiar with the laws of your state.

Gifting To Adult Children

As noted above, you can gift to minors by establishing trusts in which the donor(s) can maintain control of the assets. But there is also a way to gift to adult children which can also be effective, at least in my experience.

Consider gifting them an investment account. Here is one way it can work. Let's say you are the parents or grandparents of an adult child. The two of you agree to gift $24,000 (or some lesser amount) to your adult child or grandchild. But you only agree to gift the money if it goes into a specified investment account. And you may agree to gift another $24,000 in the following year (or years) if things go as planned.

This approach is only advised if you have a good relationship with the adult child (or whomever you wish to help). It should be laid out carefully at the onset that this investment account is indeed a long-term program, and that the money should be kept in the account and not withdrawn for expenses, spending, etc.

For donors who have the where-with-all to gift for more than one year, the main gamble is really the first year in regard to adult children. You make it clear that if they maintain the investment, rather than spending the money, you may (at your discretion and under certain specified conditions) continue to make gifts in future years. This provides a huge incentive for the beneficiary to keep the money in the investment account.

If they don't, you simply stop the gifts beyond the first year. Sounds simple, but it can be very effective.

This method of gifting will also create a big incentive to the child or grandchild to become more knowledgeable about investing in general, which is what you want. If they get into investing, that means they'll likely get more serious about saving, cutting expenses, building wealth, etc.

Another consideration in light of the market's recent downturn is the possibility of gifting an asset or investment account that has depreciated in value. Assuming the asset is one that has a good chance of regaining lost value in the future, gifting it now at a lower fair market value would transfer any future gain to the recipient and possibly reduce the donor's potential taxable estate. Plus, the donor would get more bang for the buck by gifting a discounted asset.

Of course, this and any other gifting strategy has potential tax ramifications for the donor and recipient that must be considered. The original cost basis for the gifted asset goes with it, as well as the potential tax consequences from any subsequent gains. In some cases, it may be more advantageous for the donor to sell the asset and take a tax loss rather than gifting it.

As always, the best course of action depends upon your individual situation, so it's important to seek out the advice of a qualified tax professional or estate planning attorney before pursuing any gifting strategy.

A Good Gifting Strategy, In My Opinion

Let's say that you and your spouse want to make a cash gift of $24,000 to a child or grandchild via the gift tax exclusion. And let's say you agree with me that an investment account is the way to go. Now what? In previous issues of this E-Letter, I have discussed the Scotia Partners investment programs, and we feel that these programs may offer a unique opportunity for those who are seeking a way to gift an investment account to children and/or grandchildren.

Scotia offers two investment programs that employ a proprietary investment strategy using both long and short trades, as well as 2X leverage. The Scotia S&P Moderate Growth Strategy uses trend-line reversion to identify the best days to be in the market. Because of this selectivity, the Moderate program has historically been in the market only about 25% of the time, and in the safety of the Rydex US Government Money Market Fund the remaining 75%. Of course, there are no guarantees that these percentages will remain the same in the future.

The Scotia Growth S&P Plus also uses the trend-line reversion system discussed above, but adds another money management technique to identify "overbought" and "oversold" market conditions. This strategy overlay is the "plus" in Growth S&P Plus, and results in this program being in the market more often than the Moderate program. On average, the Growth S&P Plus program has historically been in the market apprx. 35% of the time and in the money market the remaining 65%. Again, there are no guarantees for the future.

Both programs are somewhat unique in the money management business because they will exit the market immediately upon experiencing a gain, thus reducing the possibility of being "whipsawed" by volatile market action. The Moderate program also limits initial trade allocations to 50% of the account value, but will move to a 100% allocation on subsequent days. The S&P Plus program, on the other hand, always uses 100% allocations.

Our analysis has shown that both Scotia programs have thrived on the increased market volatility that began in mid-2007. The table below shows both programs' recent performance as compared to broad market indexes:

	Scotia Growth S&P Plus Strategy	Scotia S&P Moderate Growth Strategy	S&P 500 Index	Nasdaq Composite Index
YTD	91.50	61.06	(32.84)	(35.11)
1-year	116.12	63.66	(36.12)	(39.81)
2-year	70.88	35.25	(14.46)	(14.73)
3-year	46.24	24.50	(5.22)	(6.72)
5-year	N/A	19.59	0.26	(2.29)

Actual performance record (annualized) as of October 31, 2008. Past performance is not necessarily indicative of future results. Be sure to read the Important Notes at the end of this E-Letter.

Best of all, Purcell Advisory Services (Scotia's back-office and trading platform) has agreed to reduce their normal $25,000 account minimum to $24,000 in order to accommodate gifts from two parents or grandparents to a single recipient.

In order to do this, we will help you establish an account at Rydex Funds through Purcell Advisory Services, and grant Scotia the authority to manage the funds on your (or the recipient's) behalf. You will receive copies of the monthly account statements if you are the custodian for an UTMA or UGMA account.

As always, I have my own money invested in both of these programs. However, keep in mind that these are moderate to aggressive investments, so only pursue this idea if you and the recipient of the gift are comfortable with the risks involved. If this sounds like something you are interested in, or if it may be a suitable gift for someone you love, give us a call at 800-348-3601 and we will send you the necessary paperwork to review and get started.

A Time For Giving Thanks

At times like these, we often come into the Thanksgiving season feeling anything but thankful. I have to admit that the prospects of a global recession, plummeting stock markets, decimated retirement savings, growing unemployment, etc., etc. can take our eyes off of the people and things around us to be thankful for. We sometimes prefer to mutter "why me" instead of giving thanks.

However, the Bible counsels us "In everything give thanks…," even though we as humans often have a hard time following this directive. During the Thanksgiving season, I think it's important to find the silver lining around the dark clouds, hard as it may be. In doing so, we sometimes better realize the things that are really important in life.

What follows is a collection of things that I am thankful for this year.

Thanks For Long-Distance Relationships

One of the benefits of writing a nationally distributed E-Letter is that I have business relationships spread all across our great country. Sometimes it is easier to express thanks to those that you see and talk to in person than those who are only available via e-mail or telephone. However, I want to take this opportunity to thank the various long-distance relationships that mean so much to me personally.

First, I want to express appreciation for my clients, who really make all of this possible. Were it not for those who have entrusted us to manage their investments, there would be no E-Letter. My companies currently have over 1,100 clients representing every state in the Union, and many of these individuals have been our clients for over a decade. In many cases, what began as client/advisor relationships have now developed into warm friendships.

Next, I want to express my sincere appreciation to all of you who regularly read my E-Letters. Since its start in September of 2002, I have continued to be impressed at the quality of most responses to my writing. While there have been a few abusive responses, even most readers who did not agree with me offered reasoned arguments that respected the right to have a different opinion. These comments, both those that agree as well as those that disagree, help me to put out a better E-Letter.

I also want to say "thanks" to all of the staff at InvestorsInsight for providing a platform for me to get my message out to you. As I have said before, the E-Letter grew out of periodic e-mails to my clients after the 9/11 tragedy. There was so much mis-information out there that I wanted to try to help sort through the stories. A year later, InvestorsInsight saw some of my writings and requested permission to publish them as a weekly E-Letter and the rest, as they say, is history.

Other long-distance relationships to which we owe a debt of gratitude are our consultants, which include accountants, legal counsel and those that help us evaluate and track money managers. It has become a fact of life that good counsel is necessary for a successful business, and I think ours are among the best in the industry.

The final long-distance relationships I'd like to thank are the Advisors we recommend. Since we perform due diligence on each of them, we are well aware of all of the work it takes to formulate and implement a market strategy designed to manage the risks of being in the market. We also appreciate the hard work of each of their staff members who diligently process account paperwork that we send to them.

Thanking Those Close To Home

I would be remiss if I did not extend a hearty "thanks" to my internal staff. I am very fortunate in that most of my employees have been with me for over a decade. There are members of my staff that help me research topics for the weekly E-Letters, while others process information requests and speak to readers who call with questions or comments. And all of this is over and above their regular duties required in our investment management business.

During this time it is important to never forget to be thankful for your family. My wife, Debi, works in the business and is an important sounding board for many of the ideas that make their way into the weekly E-letters. She is also the CFO of the company and handles all of the detailed financial duties that allow me to concentrate on writing and overseeing our investment management business. She does all that and is still my best friend and a great Mom!

I'm also thankful for my kids. While many newspaper, radio and TV stories lament "out of control" teenagers, I am thankful that my kids are not among them. My son, Tyler, is now a freshman in college, makes good grades, goes to church regularly and works here in the office during the summers. My daughter, Jordyn, is an energetic junior in high school who also makes good grades, plays sports and has never been any trouble whatsoever.

The Biggest "Thank You" Of All

On a larger scale, I am thankful to be living in the greatest country on the face of the earth. Sure, we have our problems, especially in light of the current financial crisis, the stock market plunge and the global recession, but I'd be willing to bet that there are citizens of many other countries who would trade places with us in a heartbeat.

I'm even grateful in the wake of an election that didn't go the way I would have preferred. Only in a country where you have the freedom for political discourse can you have a situation where the will of the people speaks as loudly as it did just a few weeks ago. In 1994, a similar message was sent when the Republicans gained control. In many countries, such a shift in power cannot happen without a bloody revolution, but here in America, our votes give us the ultimate say as to the direction of the country.

I am sometimes amused at politicians and celebrities who make controversial statements, and then complain about losing votes or income. It is important to remember that our freedom of speech has never been a freedom from consequences for what we say. These complainers should be thankful that they live in a land where they have the right to say whatever they want without having to fear being hauled away in the middle of the night by the "thought police."

And finally, though there seems to be a vocal minority who want to challenge the "One Nation, Under God" concept, I don't think that we should ever forget to thank Him who has blessed our nation so bountifully. No matter what detractors may say, our nation was founded upon Biblical principles, and I think that's a big reason why America has been so successful and has lasted for so long.

Even though a vocal minority wants to push the separation of church and state to ridiculous extremes, they'll never be able to remove God's influence from the precepts upon which this country was founded, nor the solid beliefs of its people.

These are just a few things that I am very thankful for during this Thanksgiving season. As you are inundated with food, football and Christmas shopping promotions this week, please don't forget to stop for a minute, bow your head and be thankful for all of the blessings you have received during the year. I certainly am!

Wishing you a bountiful Thanksgiving holiday,

Gary D. Halbert

SPECIAL ARTICLES:

There is a Silver Lining
http://www.newsweek.com/id/163449

Despite Hard Times, Families Count Blessings
http://www.miamiherald.com/360/story/781244.html

Neither the Great Depression Nor Japan
http://www.morganstanley.com/views/gef/archive/2008/20081120-Thu.html

IMPORTANT NOTES: Halbert Wealth Management, Inc. (HWM), Scotia Partners, Ltd. (SPL), and Purcell Advisory Services, LLC (PAS) are Investment Advisors registered with the SEC and/or their respective states. Information in this report is taken from sources believed reliable but its accuracy cannot be guaranteed. Any opinions stated are intended as general observations, not specific or personal investment advice. Please consult a competent professional and the appropriate disclosure documents before making any investment decisions. There is no foolproof way of selecting an Investment Advisor. Investments mentioned involve risk, and not all investments mentioned herein are appropriate for all investors. HWM receives compensation from PAS in exchange for introducing client accounts. For more information on HWM or PAS, please consult Form ADV Part II, available at no charge upon request. Any offer or solicitation can only be made by way of the Form ADV Part II. Officers, employees, and affiliates of HWM may have investments managed by the Advisors discussed herein or others.

As benchmarks for comparison, the Standard & Poor's 500 Stock Index (which includes dividends), and the NASDAQ Composite Index represent unmanaged, passive buy-and-hold approaches. The volatility and investment characteristics of these benchmarks may differ materially (more or less) from that of the Advisor. The performance of the S&P 500 Stock Index and the NASDAQ Composite Index is not meant to imply that investors should consider an investment in the Scotia Partners Growth S&P Plus trading program as comparable to an investment in the "blue chip" stocks that comprise the S&P 500 Stock Index or the stocks that comprise the NASDAQ Composite Index. Historical performance data represents an actual account in a program named Scotia Partners Growth S&P Plus, custodied at Rydex Series Trust, and verified by Theta Investment Research, LLC. Since all accounts in the program are managed similarly, the results shown are representative of the majority of participants in the Scotia Partners Growth S&P Plus. The signals are generated by the use of a proprietary model developed by Scotia Partners. Statistics for "Worst Drawdown" are calculated as of month-end. Drawdowns within a month may have been greater. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Mutual funds carry their own expenses which are outlined in the fund's prospectus. An account with any Advisor is not a bank account and is not guaranteed by FDIC or any other governmental agency.

In addition, you should be aware that (i) the Scotia Partners Growth S&P Plus program is speculative and involves a high degree of risk; (ii) the Scotia Partners trading program's performance may be volatile; (iii) an investor could lose all or a substantial amount of his or her investment in the program; (iv) Purcell Advisory Services will have trading authority over an investor's account and the use of a single advisor could mean lack of diversification and consequently higher risk; and (v) the Purcell Advisory Services trading program's fees and expenses (if any) will reduce an investor's trading profits, or increase any trading losses.

Returns illustrated are net of the maximum management fees, custodial fees, underlying mutual fund management fees, and other fund expenses such as 12b-1 fees. They do not include the effect of annual IRA fees or mutual fund sales charges, if applicable. No adjustment has been made for income tax liability. Money market funds are not bank accounts, do not carry deposit insurance, and do involve risk of loss. The results shown are for a limited time period and may not be representative of the results that would be achieved over a full market cycle or in different economic and market environments.

A Misguided Slam On Active Management

Gary D. Halbert — Tue, 09 Sep 2008 20:17:18 GMT

IN THIS ISSUE:

"Market Timers Don't Own Yachts"
Why Market Timing Gets A Bad Wrap
Pros and Cons of Market Timing
The Bottom Line On Market Timing
A Market Timer Doing It Right
Scotia's Moderate Risk Strategy

Introduction

I might have known it would happen. The very week last month that I discussed the value of traditional market timing investment strategies in this E-Letter, market timing was attacked in a major financial publication.

About the same time that I published my August 12 E-Letter extolling the virtues of traditional market timing, mutual fund manager David Dreman, chairman and founder of Dreman Value Management, published an article in Forbes magazine that cast market timing strategies in a very unfavorable light.

Don't get me wrong, I'm used to the mainstream financial media trashing traditional market timing and other active management strategies. The same goes for many other investment professionals whose livelihoods generally depend upon their clients buying-and-holding the investment programs that they sponsor, more or less permanently.

Part of this argument goes back several years when New York Attorney General Eliot Spitzer called certain illegal practices discovered in the mutual fund industry "market timing," when they were nothing of the sort. Of course, many in the financial services industry chimed in with Spitzer, since they have never liked market timing in the first place.

No, I'm not surprised or upset that David Dreman chose to take a stand on market timing that is opposite to my view. However, I did think he was a bit arrogant (and wrong) in the way he did so. In my opinion, arrogance has no place in investment management. And when I survey some of the funds that Dreman is managing, I would think it especially true in his case.

In this week's E-Letter, I'm going to discuss the main comments that David Dreman made in his Forbes article demeaning traditional market timing. I will also provide some additional insight on the benefits of market timing as implemented by the successful active managers I recommend and certain others.

To make my point, I'll also reintroduce you to Scotia Partners, and their market timing programs that are the envy of the industry at the moment. Scotia has been knocking down exceptional returns in this very difficult stock market environment of the last 12-18 months, when most fund managers have been struggling to say the least.

As always, past performance is not necessarily indicative of future results, and there is no guarantee that Scotia will be able to continue delivering its clients with such lofty returns. However, if you are growing weary of buy-and-hold, tired of staying the course and suffering repeated market losses, I think you'll be very interested in hearing the analysis that follows.

Of Yachts & Market Timers

In David Dreman's latest Forbes piece, the jab at market timing is actually a very small part of a much larger article entitled "Bear Market Opportunities." The article's supposed purpose was to offer suggestions for investments in light of the major stock market indexes having crossed into bear market territory in July of this year. The part about market timing came in a discussion about whether investors should get out of the market, where Dreman said:

"In these circumstances, I wouldn't try to be too clever [as in get out of the market now]. You don't see market timers who own yachts. If you pack up now, chances are you'll miss a good part of the next bull market."

I will probably be among the first to agree with Mr. Dreman in regard to individual investors, since most have lousy timing (myself included). However, he paints all market timers with the same brush, and that's unfair because there are some professionals who have done very well over the years, as I will discuss in more detail later on.

But here's the rub with Dreman for me: I perceive an air of arrogance where he talks about market timers not owning yachts. How does he know if any market timers own yachts or not? Obviously, he doesn't! But he would have Forbes readers assume he knows this, nonetheless.

Dreman's questionable assertion about market timers and yachts may well be a reference to an old Wall Street story from the turn of the 20th century. According to Barry Popik, a contributor-consultant to the Oxford English Dictionary and various other reference works, the story can be traced back to an 1885 issue of the old Forest and Stream, as follows:

THE BROKERS' YACHTS. -- When Mr. W. R. Travers was at Newport last summer, a great many fine yachts lay in the harbor. "Wh-who-who-whose yacht is th-th-tha that?" he asked, pointing to one of them. "That belongs to Mr. Jones, the well-known broker." Mr. Travers raised his dexter finger slowly and brought into line another yacht. "Wh-wh-wh-whose yacht is that?" he asked with some difficulty. "Oh, that's Mr. Smith's the broker." "Wh-wh-whose is that?" pointing out still another. "That belongs to Mr. White, another broker." "W-w-well, wh-wh-where's the customers' yachts?" inquired the great Wall street joker. -- Chicago Mail.
(Source: http://www.barrypopik.com)

The above-noted passage is a story that is rarely discussed in Wall Street insider circles, for obvious reasons, but it is a story I heard about early-on in my investment career over 30 years ago. It is as valid a question today as it was over a hundred years ago.

Now back to David Dreman's latest article in Forbes. When you Google Dreman's name and the word "yacht," it seems that one of his most prolific postings is an interview that he gave in 1998…from HIS YACHT…named surprisingly, the "Contrarian." A yacht named Contrarian owned by a buy-and-hold advocate? Honest folks, you can't make this stuff up!

The implication is clear – investors who follow buy-and-hold investment strategies such as Mr. Dreman promotes can afford yachts, while those who opt for market timing in an effort to manage risk cannot. On a more basic level, it's as if he is saying that buy-and-hold strategies are successful, and all market timing strategies are not.

Another thing that those promoting buy-and-hold strategies know is that the longer investors remain invested, the longer the Advisors continue to receive management fees. As a general rule, selling a fund or otherwise moving to cash stops these management fees, and thus the Advisor's revenue stream. In other words, capital preservation for you may cause revenue cessation for them, so it's no big surprise that they are against market timing.

The bottom line is that while a buy-and-hold scenario may or may not work best for investors over any given time frame, it most certainly benefits fund managers who get paid only if assets remain invested. In our position as a "manager of managers," I often explain to clients that few, if any, fund managers will ever tell you to fire them, since doing so would wreak havoc on their revenue. Think about this next time you're out on your yacht or wherever.

Market Timing 101

As I noted above, having Wall Street bigwigs and the financial press criticize traditional market timing is nothing new. As far back as I can remember, Wall Street has pushed buy-and-hold strategies, especially after the explosion in the number of mutual funds in the 1990s.

They even present misleading and downright inaccurate arguments against market timing in an effort to dissuade clients from choosing such strategies. I discuss these articles in detail on Page 9 of my Absolute Return Special Report. Thus, I think it's a good idea to take a step back and explain exactly what a traditional market timing strategy does.

As I mentioned in my August 12 E-Letter, traditional market timing is nothing more than simply seeking to "take you out of the market and into the safety of cash, or hedge long positions, during major market downturns." Obviously, it takes a lot of sophistication to know when to exit the market as well as when to get back in. In fact, I often tell my clients that the real value of a market timer is not knowing when to get out of the market, but knowing when to get back into a fully invested position again.

To be fair to David Dreman, it's the getting back into the market that is probably the meat of his argument against market timing on the part of individual investors, and even many professionals who try their hand at the strategy. I'm sure he sees lots of investors, as we do, that try to time the markets on their own and end up sitting in cash for extended periods of time. Then, after the market goes up for a period of time, they jump back in about the time the market does an about-face, and they lose even more money.

A traditional market timing strategy has the potential to not only provide steady returns, but also to limit drawdowns, and smooth out the path to your financial goals. It just makes sense that limiting losses can help to control the emotions that might otherwise compel you to exit the market when losses get too high. Contrast this with Wall Street's buy-and-hold mantra of staying invested at all times, including bear markets.

Mr. Dreman's strategy has only a slightly different twist. His bear market strategy is to ride the market down, and then look for opportunities to buy the stocks of good companies upon a dip in price caused by negative news. He says:

When that happens, you should sell less-promising stocks to raise cash to buy the companies the market has panicked on.

While I'm not a yacht-owning billionaire, what Mr. Dreman describes above sounds a lot like market timing, except that he apparently wants to wait to sell the bad stuff (losers) until he finds more promising stocks. It just seems to make sense to me that if you have losing stocks, shouldn't you sell them before the market takes them down further. That way, you would theoretically have more cash to buy the promising stocks later on.

I think it's also important to note that there are a number of mutual funds that are breaking with the fully invested mindset and are now choosing to hold significant cash positions rather than holding on to stocks that are likely to decline in price during down markets. Most will not come out and call it market timing, but that's exactly what it is.

Pros & Cons of Market Timing

While I have been promoting market timing strategies to my clients for well over 10 years, I have to admit that these programs have both advantages and disadvantages just like any other money management strategies. Here are some of the pros and cons associated with most market timing strategies. Here are some of the potential advantages:

Superior Risk-Adjusted Returns – Most successful market timers use strategies that seek to exit the market and move to the safety of money market funds, or "hedge" long positions, during market downturns. As such, the drawdowns during significant market downturns can be reduced, thus leading to superior risk-adjusted returns.

Professional Management – Most investors are not equipped to handle trading in today's very volatile stock markets. By using successful market timers, one can rely on proven strategies that have delivered "absolute returns" over time. Absolute returns refers to an investment strategy that seeks to provide consistent positive returns with minimal losses in both up and down markets. While you should never enter into a market timing strategy thinking that you will never incur a loss, the overall goal of this strategy is to keep losses to a minimum while also maximizing absolute returns.

Use of Leverage & Short Selling – Market timing strategies often use leverage, which involves the use of various financial instruments and techniques to increase the potential return of an investment. Many index mutual funds now offer "2X" leverage, meaning that they reflect 200% of the daily return of the underlying index. By employing leverage, a market timing strategy can get more "bang for the buck" on those days in which it is in the market.

Short selling is another strategy often used by market timers that involves investing in such a way that a drop in a specified equity security produces a portfolio gain. There are numerous specialized mutual funds that provide returns that are the inverse of a wide variety of market indexes – so called "short" or "inverse" mutual funds that have the potential to make money in falling markets. However, they can also lose money in up markets if they make the wrong call, so just remember that there are no guarantees.

It is important to note that the use of leverage and/or short selling strategies can also increase the risk of a market timing strategy, just as in other investment strategies.

Here are some of the potential disadvantages of most market timing strategies.

No Market Timing Strategy Is Perfect – I'll be the first to admit that market timing strategies sometimes stop working in certain market environments, in some cases after performing well for many years. Using an Advisor who employs a market timing strategy is not a "set it and forget it" investment. It is important to continue to monitor the performance and trading of the program to see how its current performance compares to its historical norms. For clients of Halbert Wealth Management, we do this monitoring for them on a daily basis.

Higher Fees – As a general rule, management fees associated with market timing strategies are higher than those for most buy-and-hold investment options. Market timers and other active managers typically charge management fees of 2-2½% annually. Skeptics of market timing often focus on the higher management fees, but market timers who can consistently produce superior risk-adjusted returns above and beyond their fees are worth consideration. The key is to compare market timing performance net of fees to other alternatives. FYI, all of the performance information that I produce for the Advisors I recommend is net of fees.

Tax Efficiency – Another disadvantage of many market timing programs is that they trade frequently and produce short-term gains and losses. This disadvantage may be offset by investing IRA or other tax-qualified money rather than taxable assets, or by investing in low-cost variable annuity contracts which also defer taxation until the gains are withdrawn.

The above list of advantages and disadvantages is not exhaustive, but it does provide a list of idea of things to be aware of when evaluating market timing programs. My company tries to maximize the potential advantages for our clients while minimizing the potential downsides. We do this by subjecting any potential market timing Advisor to a strict due diligence review, which includes either an on-site visit to their offices or a face-to-face meeting here in Austin.

The Bottom Line On Market Timing

Many Wall Street types, investment professionals and financial planners have advocated for years that "market timing" does not work. When it comes to most individual investors doing their own thing, I would have to agree. Most investors are simply too emotional to effectively know when to get in or out of the markets.

So what about professional market timers? We have examined hundreds of professional money managers over the years who practice various types of market timing. Frankly, most have not been successful, or at least did not deliver results that were measurably better than buy-and-hold returns. So does this mean that market timing doesn't work, as Mr. Dreman concludes?

Certainly not.

While most market timers have either not been successful, or have not added value above and beyond their higher management fees, there are some professional market timers that have been very successful over time. The key is how to find them.

We look at hundreds of professional money managers each and every year. We spend hundreds of thousands of dollars each year in doing so. We go to conventions where they gather. We make due diligence trips to their offices around the country to investigate, ask the tough questions and dissect their past performance records.

The point is, most market timers and active money managers fail our rigorous due diligence tests. Does this mean that market timing does not work, as Mr. Dreman concludes? NO. It merely means that you have to do a lot of searching to find those market timing programs that have been successful. They are out there, if you have the know-how and the budget to find them. That is what we do. For example…

A Market Timer That Works

As I noted above, most individuals fail at trying to time the market. I can also attest to the fact that most professionals who try to time the market also fail. We constantly monitor databases containing hundreds of money managers, many of whom employ market timing strategies. Most are mediocre, some are terrible, and a very few rise to the top of the list. One such top manager is Cliff Montgomery of Scotia Partners, LLC.

Since early June, I have mentioned Scotia several times in this E-Letter. That's because Cliff's proprietary strategy has been able to navigate a difficult market that has not only put all major stock market indexes under water (both the Dow Jones Industrial Average and the S&P 500 Index are down over 15% YTD as this is written), but has also proved difficult for even many active money managers. While Scotia's past accomplishments cannot guarantee favorable future results, I do think the way Cliff approaches the market merits your consideration.

The Scotia program getting the most attention at the present time is the Growth S&P Plus Strategy. As of the end of August, the Growth S&P Plus program has a year-to-date gain of 73.30%. (Past results are not necessarily indicative of future performance.) Needless to say, this compares very favorably to the major stock market indexes, which are nursing double-digit losses for the year. Additional performance information on the Growth S&P Strategy is presented below. Also be sure to read all of the Important Notes and disclosures that follow my signature at the end of this E-Letter:

Performance Statistics
(Net of all fees and expenses)

PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
Please see Important Notes at the end of this E-Letter.

A Scotia Program For Less Aggressive Investors

I recently introduced another program traded by Scotia Partners that is more suitable for less aggressive investors. However, I made this introduction in my annual discussion of the Johnson O'Connor Research Center for those needing assistance in finding their life's calling. Since many of you have read this in past years, you may not have seen the information about Scotia's S&P Moderate Growth Strategy, so I'll repeat the introduction below.

When I introduced Scotia's Growth S&P Plus Strategy in June, I noted how Cliff's proprietary strategies seemed to have actually benefited from the high level of volatility we have seen in the markets since the onset of the subprime mortgage debacle and the resulting housing slump and credit crunch. Accordingly, the strategy employed in the Scotia Growth S&P Plus Strategy makes it an aggressive investment.

Some of the investors who expressed an interest in Scotia's S&P Plus program later decided not to invest because they were not comfortable with the aggressive nature of that program. However, I have good news for investors who want a more moderate-risk program that still has a leveraged, long/short exposure.

The Scotia S&P Moderate Growth Strategy uses the same basic trading model as the Growth S&P Plus program, but does not include the overbought/oversold overlay that helps to make the S&P Plus program more aggressive. As a result, the Moderate Growth program trades less often than the S&P Plus, and limits initial trades to 50% of the account balance. While allocations can reach 100% of the account balance in the Moderate Growth program if Scotia's model continues to indicate a high probability of success, the average historical allocation has been in the 61% range, indicating that 100% allocations are likely to be relatively infrequent.

Another benefit of the S&P Moderate Growth Strategy is that Scotia actually began trading this program before the Growth S&P Plus began trading, so the Moderate program has an additional year of track record. In fact, the Moderate Growth program reached its five-year track record milestone at the end of July. Over that period of time, the Moderate Growth program has turned in a solid, risk-adjusted performance.

From its inception through August 2008, the S&P Moderate Growth Strategy has produced an annualized return of 14.81%, with a worst-ever month-end drawdown of only -4.76%. The Moderate Growth program has done even better during the recent bear market, producing a gain of 15.05% in 2007, a year-to-date gain of 28.87% as of August 31, 2008, and a 12-month gain of 39.98%, also as of the end of August.

Again, these are actual results net of all fees and expenses. As always, past performance is not necessarily indicative of future results. Additional detailed performance information on the S&P Moderate Growth program is as follows:

Performance Statistics
(Net of all fees and expenses)

PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
Please see Important Notes at the end of this E-Letter.

Please be sure to read the Important Notes and disclosures that follow my signature below.

I personally feel that the increased volatility and uncertainty in the stock markets that we've seen over the last year and a half will likely continue well into next year. Scotia seems to be one of the few professional money managers with a system that actually thrives on volatility.

Conclusions

Though my review of David Dreman's recent Forbes article has been a bit tongue-in-cheek, I hope that it has helped you to understand that money managers whose livelihoods depend upon your staying invested in their funds will likely never recommend market timing as a valid money management strategy.

Likewise, the financial press is not likely to embrace the idea of market timing because they don't have the foggiest notion of how to find a successful professional market timer, and they are so hung up on management fees they are convinced (right or wrong) that market timing will never be able to compete with low-cost index funds and exchange-traded funds (ETFs).

However, you now know that there are market timing money managers who do have long-term successful track records that showcase their ability to manage the risks of being in the market. And more importantly, when to exit the market or hedge long positions during downturns.

These types of successful active money managers are out there. But you will likely never hear about them from the traditional investment outlets, and you are unlikely to find them on your own. That's where we come in.

If you are tired of the volatile ups and downs of index investing or asset allocation strategies, or if you would like to learn more about Scotia's market timing investment programs for a portion of your portfolio, I urge you to contact one of our Investment Consultants at 800-348-3601, via e-mail at info@halbertwealth.com, or complete one of our Scotia Partners online request forms.

Very best regards,

Gary D. Halbert

IMPORTANT NOTES & DISCLOSURES

Halbert Wealth Management, Inc. (HWM), Scotia Partners, Ltd. (SPL), and Purcell Advisory Services, LLC (PAS) are Investment Advisors registered with the SEC and/or their respective states. Information in this report is taken from sources believed reliable but its accuracy cannot be guaranteed. Any opinions stated are intended as general observations, not specific or personal investment advice. Please consult a competent professional and the appropriate disclosure documents before making any investment decisions. There is no foolproof way of selecting an Investment Advisor. Investments mentioned involve risk, and not all investments mentioned herein are appropriate for all investors. HWM receives compensation from PAS in exchange for introducing client accounts. For more information on HWM or PAS, please consult Form ADV Part II, available at no charge upon request. Any offer or solicitation can only be made by way of the Form ADV Part II. Officers, employees, and affiliates of HWM may have investments managed by the Advisors discussed herein or others.

As benchmarks for comparison, the Standard & Poor's 500 Stock Index (which includes dividends), and the NASDAQ Composite Index represent unmanaged, passive buy-and-hold approaches. The volatility and investment characteristics of these benchmarks may differ materially (more or less) from that of the Advisor. The performance of the S & P 500 Stock Index and the NASDAQ Composite Index is not meant to imply that investors should consider an investment in the Scotia Partners Growth S & P Plus or the Scotia Partners S&P Moderate Growth trading programs as comparable to an investment in the "blue chip" stocks that comprise the S&P 500 Stock Index or the stocks that comprise the NASDAQ Composite Index. Historical performance data represents actual accounts in programs named Scotia Partners Growth S&P Plus and Scotia Partners S&P Moderate Growth, custodied at Rydex Series Trust, and verified by Theta Investment Research, LLC. Since all accounts in the program are managed similarly, the results shown are representative of the majority of participants in these programs. The signals are generated by the use of a proprietary model developed by Scotia Partners. Statistics for "Worst Drawdown" are calculated as of month-end. Drawdowns within a month may have been greater. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Mutual funds carry their own expenses which are outlined in the fund's prospectus. An account with any Advisor is not a bank account and is not guaranteed by FDIC or any other governmental agency.

When reviewing past performance records, it is important to note that different accounts, even though they are traded pursuant to the same strategy, can have varying results. The reasons for this include: i) the period of time in which the accounts are active; ii) the timing of contributions and withdrawals; iii) the account size; iv) the minimum investment requirements and/or withdrawal restrictions; and v) the rate of brokerage commissions and transaction fees charged to an account. There can be no assurance that an account opened by any person will achieve performance returns similar to those provided herein for accounts traded pursuant to the Scotia Partners Growth S&P Plus and Scotia Partners S&P Moderate Growth trading programs.

In addition, you should be aware that (i) these programs are speculative and involve a high degree of risk; (ii) the Scotia Partners trading programs' performance may be volatile; (iii) an investor could lose all or a substantial amount of his or her investment in the programs; (iv) Purcell Advisory Services will have trading authority over an investor's account and the use of a single advisor could mean lack of diversification and consequently higher risk; and (v) the Purcell Advisory Services trading program's fees and expenses (if any) will reduce an investor's trading profits, or increase any trading losses.

Returns illustrated are net of the maximum management fees (which are deducted in full quarterly, and not accrued month-by-month), custodial fees, underlying mutual fund management fees, and other fund expenses such as 12b-1 fees. They do not include the effect of annual IRA fees or mutual fund sales charges, if applicable. No adjustment has been made for income tax liability. Money market funds are not bank accounts, do not carry deposit insurance, and do involve risk of loss. The results shown are for a limited time period and may not be representative of the results that would be achieved over a full market cycle or in different economic and market environments.

Retirement Focus - More Post-Retirement Investing

Gary D. Halbert — Tue, 15 Jul 2008 19:57:50 GMT

by Mike Posey

IN THIS ISSUE:

A Primer On Variable Annuities
Variable Deferred Annuities
Disadvantages Of Variable Deferred Annuities
Variable Annuities Continue To Improve
Retirement Tidbit – Making The Most Of Retirement

Introduction

This week, I am going to continue the series of E-Letters dedicated to investing during retirement. In past Retirement Focus issues, I have covered how to determine how much money is enough at retirement, as well as the various ways of taking retirement income. However, the success of any withdrawal option is going to hinge upon the way your nest egg is invested during retirement.

In my initial discussion about post-retirement investing in the May 27 Retirement Focus, I mentioned that there are a myriad of ways to invest during the payout phase, each with its own set of advantages and disadvantages. For purposes of simplifying our discussion, I categorized these investment strategies into the following broad categories:

Immediate Annuities;
Fixed Income Alternatives;
Variable Annuities;
Asset Allocation Alternatives;
Actively Managed Strategies; and
Other Alternatives.

I covered the first two of these alternatives in the May 27 E-Letter. However, I realize that immediate annuities and fixed income alternatives are considered to be among the most conservative of investment strategies, so they may not be able to provide the level of income needed for retirement. This is especially true in light of Baby Boomers who have not saved enough for retirement, as well as the prospect of ever-increasing life expectancies.

This week, I'll delve deeper into alternative #3, variable annuities, which have the potential for higher gains and the prospect of higher withdrawals during retirement. However, as we move up the list of post-retirement investment alternatives, it is also important to note that we also increase the risk of investment loss.

I'm also going to revive the “Retirement Tidbit” concept that I discussed when I first started writing these Retirement Focus E-Letters. These tidbits are ideas or resources related to retirement that probably wouldn't fill up an entire e-letter, but are still important to mention. This week, our tidbit is even more interesting in that it involves a publication written by a Forecasts & Trends E-Letter reader. I think you'll enjoy what he has to say.

I want to remind you that any investment information provided in this E-Letter is general in nature, and should not be construed as investment or insurance advice. You should always evaluate insurance and investment options in light of your personal financial situation, retirement goals and any special circumstances you may have. Ideally, you should consult a qualified insurance and/or investment professional who can take the time to review your situation and tailor an investment approach to meet your needs.

Variable Annuity Investments

Variable annuities have been around for a long time, and are experiencing a new growth trend as the Baby Boom generation is beginning to take retirement a little more seriously. As I mentioned in the May 27 Retirement Focus issue, a variable annuity is often defined as being a “mutual fund in an insurance wrapper,” but not everyone knows what that means.

In this article, I'll seek to better explain the variable annuity concept as well as discuss when these contracts may be the best alternatives for part of your post-retirement investing. Note, however, that a discussion about all of the characteristics of variable annuities is far beyond the scope of this brief E-Letter. Since the theme of this series of E-Letters is how to invest during retirement, I'll keep most of my comments focused on the features of variable annuities that may make them suitable for that phase of your investing life.

Basically, a variable annuity is a type of deferred annuity contract where returns are dependent upon the market performance of a selected group of investments. Thus, variable annuities differ from fixed annuities in that returns are tied to the market and not a pre-determined fixed rate of return set by the insurance company. They also differ in that market action can result in losses as well as gains in a variable contract.

To access market-rate returns, each variable annuity offers a group of equity and/or bond “sub-accounts,” which are essentially mutual funds within the annuity. While various types of insurance provisions can guarantee the original principal and sometimes even certain gains upon the death of the annuitant, there are usually no guarantees as to a variable annuity's annual performance as there are in fixed annuities. There are, however, certain “living benefit” riders that I will discuss later on that can provide some measure of performance guarantee – for a fee.

As a practical matter, the management of the sub-accounts available in variable annuities is usually a matter of using asset allocation and/or active management investment strategies, both of which are alternative post-retirement investment strategies that will be covered in later Retirement Focus issues. Some companies also have pre-set portfolios from which to choose, but these are usually based on an asset allocation strategy tailored to various risk tolerance categories.

There are two basic types of variable annuities – variable immediate annuities and variable deferred annuities. The variable immediate annuity is much like the fixed immediate annuities I wrote about last time, in that they are designed to make periodic (usually monthly) distributions to an annuitant during retirement. The variable immediate annuity differs from the fixed version in that the amount of the periodic payment can change over time based on investment returns, while fixed immediate annuity payments are usually the same amount for life.

The potential for payments from a variable immediate annuity to increase over time can be a welcome feature for annuitants who are concerned about maintaining their purchasing power throughout retirement. As life expectancies continue to grow longer, the variable immediate annuity provides the potential for keeping up with the ravages of inflation. However, investment gains are obviously not guaranteed in a variable immediate annuity. If repeated losses occur, the payment from a variable immediate annuity could end up being far less than what would have been available from a fixed annuity.

To help counteract this disadvantage, some variable immediate annuity sponsors have come up with a “floor” payment, usually consisting of 80% or 85% of the amount of monthly payment at the beginning of the contract. With this feature, even if the sub-accounts incur investment losses, the monthly benefit will never fall below this floor. However, this added insurance comes at the cost of higher fees which, in turn, reduce the investment return of the sub-accounts.

The use of variable immediate annuities is growing, especially as Baby Boomers start hitting early retirement age. For some, the potential for monthly income payments to grow over time may help to offset the fact that they saved too little over their working lifetimes. For others, however, the possibility of receiving lower payments over time due to investment losses makes variable immediate annuities less attractive than the fixed immediate annuity. As a compromise, some investors include both fixed and variable immediate annuities in their retirement portfolios to provide a combination of stability and the potential for future gains.

Variable Deferred Annuities

The second type of variable annuity is the variable deferred annuity. Much like the fixed deferred annuity I discussed in my May 27 E-Letter, the variable deferred annuity is designed to be a way to accumulate savings on a tax-deferred basis over an investor's working lifetime. Ideally (at least for the insurance company), the variable annuity investor will convert the accumulated value at retirement into a variable immediate annuity income stream. However, according to most reports, very few deferred annuity contracts are ever “annuitized.”

While variable deferred annuities are typically an investment vehicle used during the accumulation phase of an investor's working lifetime, they are now being marketed to retirees in ever-increasing numbers. Part of the reason is that investors do not usually like putting all of their money into an immediate annuity where it is usually locked up for the rest of their lives with little or no liquidity. Another reason for this increased popularity among retirees is that insurance companies have become very creative in offering new riders for variable annuities that make them more attractive as a post-retirement option.

Even though variable deferred annuities might be suitable for both pre- and post-retirement investors, the focus of this E-Letter is investment alternatives during retirement. Thus, I'll focus most of my comments on features of variable deferred annuities that retirees find beneficial. I hope to do a separate, more general E-Letter on pre-retirement uses of variable deferred annuities sometime in the future.

That being said, the primary benefit of a variable deferred annuity in both pre-and post-retirement investment scenarios is tax-deferral. Gains within the contract are generally not taxed until withdrawn upon annuitization or surrender of the contract. This feature can be especially attractive when using active management strategies that produce short-term gains and losses.

In the past, variable deferred annuities were not viewed to be optimum post-retirement investments since periodic withdrawals were not encouraged, and sometimes even penalized. This restriction was generally the result of the long-term nature of the contract, as well as large up-front selling commissions that made it necessary for the insurance company to encourage keeping the contract in force, even if it meant subjecting the investor to significant surrender charges upon early termination.

However, as fewer workers are being covered by pension plans with guaranteed monthly benefits, the variable deferred annuity has evolved to be more “withdrawal friendly” for those in retirement. While many contracts still pay significant up-front commissions to the insurance agent and have surrender charges for early termination, they also provide for certain amounts of annual distributions that are not subject to an early withdrawal charge. Some have even gone so far as to provide for guaranteed levels of withdrawals even if the investment experience is negative.

In the insurance industry, such benefits are called “living benefits,” in that they are guarantees paid during the lifetime of an annuitant rather than to beneficiaries upon death. Living benefits can come in a variety of forms, with some being more important before retirement, and others afterwards. The living benefits most applicable to post-retirement investing are as follows:

Guaranteed minimum income benefits provide for a monthly income based on a stated annual growth rate, usually 5% to 7%, even if the actual investment results in the sub-accounts is less (or even negative). Note, however, that this benefit is generally only available if you take periodic income from the contract, but not if you want to surrender the contract for a lump sum.
Guaranteed minimum withdrawal benefits that allow an annuitant to withdraw a fixed percentage of the annuity premiums (usually 5% to 7%) for a specified period of time. Such withdrawals can continue until the end of the specified time, or until all premiums have been withdrawn. This feature guarantees return of all premiums, even if investment losses result in the loss of some of the original principal. However, investment gains can increase allowed withdrawals over time.
Guaranteed minimum withdrawals for life allow an annuitant to withdraw a smaller percentage, usually 4% to 5%, of the original premium for life, without regard to investment performance. Thus, these payments continue even after they reach the amount of original premium paid, and even if poor investment performance erodes principal. As above, good investment performance can increase future withdrawals.

These guaranteed income features are what really separates variable deferred annuities from mutual fund investment portfolios. Sure, it's possible to set up an investment portfolio to pay a certain level of income, and have that income vary with the performance of the underlying investments. It may even be possible to guarantee principal over a certain period of time using zero coupon bonds. However, mutual fund companies and brokerage firms are not going to guarantee all or part of that payment for the life of the investor. Insurance companies, on the other hand, specialize in such guarantees.

A final benefit of a variable deferred annuity may be asset protection. In some states, money held in annuity contracts may be protected from creditors. In such cases, physicians and others in occupations with a high economic risk may find that asset protection may offset any negatives associated with these contracts. However, asset protection is not available in all states, so it's important to contact your state insurance regulator to determine whether or not this benefit is available where you live.

That's the good news. The bad news is that all of the favorable features discussed above come at a cost, and sometimes this cost can be considerable. Plus, the cost is sometimes not measured in dollars, but rather in lost flexibility or access to your principal. Therefore, along with the various advantages discussed above, it's also important to review some possible disadvantages of variable deferred annuities as a post-retirement investment.

Drawbacks Of Variable Deferred Annuities

In the investment industry, the variable deferred annuity is either one of the most valued or most maligned investments, depending upon your perspective. As I discussed above, variable deferred annuity contracts offer the ability to participate in market gains and losses on a tax-deferred basis, as well as provide some level of insurance benefit to heirs. Some also offer living benefits that offset some of the criticisms of earlier generation variable annuity contracts.

Outside of the insurance industry, however, variable deferred annuities generally get a cold reception. Liz Pulliam Weston has an article about variable deferred annuities on the MSN Money website entitled, “The Worst Retirement Investment You Can Make.” Just the title gives you some idea of how many Investment Advisors view variable annuities. This and many other similar articles I have reviewed discuss that the benefits offered by variable deferred annuities are more than offset by negative features of these contracts. These disadvantages include, but are not limited to, the following:

Tax deferral or tax trap? As noted above, one of the most frequently cited advantages of variable deferred annuities is the deferral of taxation on investment gains. However, what's not always said is that a variable deferred annuity converts all types of gains to ordinary income. Thus, there are no long-term capital gains or dividend tax treatment, just ordinary income subject to the standard tax rates. Tax rules also dictate how much of each distribution is taxable income and how much is return of principal, which can reduce tax planning flexibility.

In retirement, any amount paid in income taxes obviously reduces the amount available to spend for life's necessities. The current tax rates for dividends and long-term capital gains are very attractive, and can reduce the tax bite on retirement distributions. That being the case, the tax deferral available in a variable deferred annuity may not be worth the difference in tax rates that may apply. Should dividend and capital gains tax rates rise in the future, then this disadvantage may become less of a factor.
Next, opponents of variable deferred annuities cite the penalties for early withdrawal as a major negative. While there is a special penalty tax that applies to distributions prior to age 59½, that is not a consideration for this article as we are talking about post-retirement investments which usually occur after that age. Instead, the issue is being locked into an insurance contract by way of surrender charges that can last 10 years or more, depending upon the contract.
Variable deferred annuities also have a death benefit that guarantees beneficiaries receive no less than the premiums paid, and sometimes even part of the gains earned on the contract. Opponents, however, say that this insurance is often of little value and is overpriced.
Advisors also complain that all of the bells and whistles now available in variable deferred annuity contracts make them far more complex, both for agents to sell and clients to understand. This complexity, or what we like to call “moving parts,” can have a far different effect than what is anticipated by the annuitant.
Some of the insurance companies offering guaranteed living benefits do so on the condition that the premium is invested only in designed portfolios established by the company. This, in turn, reduces investment flexibility for the investor in exchange for guaranteed levels of income or withdrawals.
Fees – Fees – Fees. As in just about any endeavor in life, variable annuity guarantees come at a cost. In some cases, the cost to provide insurance, guaranteed benefits and investment management shaves quite a bit off of the return realized in the sub-accounts. Morningstar reports that the average variable deferred annuity contract charges fees of 2.44%, including fees for managing the sub-accounts, while the average open-ended mutual fund charges 1.32%.
Perhaps the biggest rub comes in the form of surrender penalties for early termination, since these are usually designed to cover the large up-front commissions paid to insurance agents on many variable deferred annuity contracts. It seems that the fee-only Investment Advisor world has a problem with those who sell on commission, and perhaps they always will.
This conflict is at least partially due to the fact that relatively high front-end commissions coupled with restricted exit provisions lend themselves to questionable sales practices. Consequently, the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) keep variable annuity sales practices under close regulatory scrutiny. Stories abound of agents who have sold variable annuities to investors who were unsuitable for such investments, primarily for the purpose of maximizing their commissions.

While the above discussion of advantages and disadvantages does not contain every possible pro or con of variable annuities, my primary focus has been to make you aware that they are not the one-stop retirement investments that some free-lunch seminars make them out to be. Where they work, they can be a big advantage. Where they don't, however, they can be disastrous.

Variable Annuities Continue To Improve

So, how should a retiree approach the issue of buying a variable annuity? The first thing to do is realize that deferred and immediate variable annuity contracts are two of many tools available to retirees to provide income during retirement. However, they are not necessarily the best choice for all retirees. Variable annuities seem to work best for investors who value guarantees and are concerned about outliving their money, but who also want the potential to share in market gains over time.

Since I have worked for a life insurance company in the past, my opinion may be a little different than those of other Investment Advisors. I tend to think that both variable deferred and immediate annuities have a place in some investors' portfolios, but the situation has to be just right. I also think that the insurance industry is getting close to a more viable combination of guarantees and features at an acceptable level of fees.

For example, several companies have already come out with “longevity insurance,” which is an immediate annuity that is purchased at retirement, say age 65, but starts paying a lifetime monthly income at age 80 or 85. This type of policy allows retirees to take larger withdrawals in early years from other assets, knowing that a safety net will kick in later on.

We have also seen the insurance industry roll out some variable annuity policies aimed at fee-only Investment Advisors instead of commissioned agents, and I expect these offerings will be expanded in the future. A good example of this is a variable annuity policy that we offer to our clients that has no commissions, no surrender penalty and no insurance charges. The only fee is a flat monthly charge to maintain the insurance policy, plus the regular investment management fees charged by our recommended Advisors.

As you can see, the insurance industry is being very proactive in meeting the needs of present and future retirees, and I look for them to continue to provide innovative retirement solutions in the future. With 78 million Baby Boomers approaching retirement, they have every incentive to do so.

Retirement Tidbit – Making The Most Of Retirement

Since I began writing these Retirement Focus issues last year, the primary focus has been on the financial aspects of retirement. Working for an Investment Advisory firm, these issues tend to be our primary focus, especially as we read that members of the Baby Boom generation have not set enough money aside for their eventual retirement. However, the financial aspect of retirement is just one of many things to consider for those who are at or near retirement age.

Recently, I was very pleasantly surprised to receive a package in the mail from one of our readers, Dave Brazier. While Dave praised the work I had done on the financial aspects of retirement, he reminded me that another important aspect for retirees is how best to utilize their time in such a way as to “bring them fulfillment and enjoyment in their retirement years.”

Dave's comments immediately made me think back to the many individuals I have known and talked to about their retirement. When I was younger, I didn't think much about time management in retirement, since it seemed to me that retirees had all the time in the world to do anything they wanted. However, as I worked in the retirement field and talked to more people who were actually in retirement, most said that the reality of retirement is very different than what they had planned.

We often joke about retirees spending all of their time traveling or fishing or playing golf, but I learned from my retired friends that there is only so much fishing or golfing you can do before boredom sets in. In other words, these things were great as diversions from a busy workload, but were not as much fun when they became the “only thing to do.”

Fortunately, Dave has a solution for our readers who are retired, or who are nearing that goal. Since his own retirement in May of 2000, Dave has explored ways to successfully move from working full time to a fulfilling retirement. The results have been collected in a book he has entitled, “Have the Time of Your Life in Retirement.” This book offers a wealth of planning and time management advice drawn from Dave's own retirement experience. However, rather than describing it myself, I'll put it in Dave's own words from his letter:

“The enclosed book…describes a simple process to help people transition from the work force into retirement and provides insights to help retirees enrich their retirement living. Almost everyone who reads [my book] will find an activity or some advice that will enhance their retirement experience.”

“The book describes a key process I used to help me in my successful transition to a fulfilling retirement in New Hampshire. This tool helped me broaden my activities to include trout fishing, keeping a journal, cooking, hunting wild mushrooms, making maple sugar, doing crossword puzzles, making apple cider, etc. [makes you wonder how he found the time to write a book, doesn't it? JMP] It has been a process that has continued to guide me over the last eight years. Retirement should be an exciting phase of people's lives and this book can help retirees achieve this objective.”

“[My book] is ideal for the person who is considering or in the process of retiring. Often people do not adequately prepare for life after working and boredom sets in after the initial retirement euphoria begins to fade. This book can help prevent this phenomenon. It is also ideal for those who have retired and have not achieved the excitement or fulfillment they expected. This book can help them explore the available alternatives. In addition, it can also serve as a valuable resource for those who are in retirement and having a great time. I know I am always looking for new ideas or activities to add to my ‘potential to do' list. This book was written to aid people in finding new passions in life.”

I think the thing that struck me the most about Dave's letter and his book is his use of the words “excitement” and “fulfillment.” I have to admit that when I think of retirement, “rest” is the first word that comes to mind. However, Dave seems to realize that “rest” can lead to “rust,” and I've always heard that it's better to wear out than rust out.

I found Dave's book to be concise and easy to read. It's only 90 pages, including Appendices, so it's easy to read in one sitting. However, if you employ all of his suggestions and checklists, it will keep you busy much longer, possibly for the rest of your retirement years. It has the ring of a book by someone who has not only mastered his own retirement strategy, but who earnestly wants to help others to find the same level of fulfillment.

Dave's book is available from Amazon.Com, Barnes and Noble, www.tatepublishing.com or www.retiretothegoodlife.com, and is distributed by Ingram/Spring Arbor, a major book supplier. The price on Amazon is only $9.99, a small investment to make for an enjoyable retirement. Neither ProFutures Investments nor Halbert Wealth Management will receive any compensation should you decide to purchase Dave's book.

I highly recommend this book to anyone who is at or near retirement, and I think it's a great “how-to” book for just about anyone contemplating how they will spend their retirement years. Even if you have been retired for a number of years, Dave's book may be able to help you find additional activities that can lead to greater fulfillment.

There are also a number of other resources available to retirees that can also help add enjoyment to their retirement years. One that I came across years ago is an Internet-based organization with the address of www.2young2retire.com. This website has a number of activities and resources to consider, and also has a periodic e-mail update available by subscription. Of course, you can also obtain information about retirement activities from the AARP website (www.aarp.org), if you can make it past all of the political stuff.

Conclusion

As we have seen, variable deferred and immediate annuities are among the many tools available to retirees and financial professionals. While they offer many advantages in both pre- and post-retirement scenarios, they also have some significant disadvantages which must also be addressed before making an investment.

Reviewing all of the pros and cons of these investments is especially important since most contracts have significant surrender charges if you terminate the investment within the surrender period, which can be a period of seven years or more. Thus, it's not something that you can buy now and change your mind about next year.

You should also be aware that the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) have both warned seniors about “free-lunch” seminars that subject attendees to high-pressure sales tactics in an attempt to get them to invest in variable annuities. According to these regulatory bodies, such seminars often misrepresent the benefits of variable annuities and downplay any disadvantages of these contracts. Be wary of any such invitations and never commit to purchase a variable annuity, or any other investment, before taking the materials home and thoroughly checking them out.

That's it for this week. In my next Retirement Focus issue, I'll continue discussing the various ways to invest during retirement. Until then, if you have any questions about the options given above, or would like me to cover a specific investment option, please feel free to contact me at info@halbertwealth.com.

Best regards,

Mike Posey

SPECIAL ARTICLES

Variable Annuities: Emerging From the Dark Side?
http://spwfe.fpanet.org:10005/public/Unclassified%20Records/FPA%20Journal%20March%202007%20-%20Focus_%20Reconsidering%20Annuities.pdf

"Free Lunch" Investment Seminars — Avoiding the Heartburn of a Hard Sell
http://www.finra.org/InvestorInformation/InvestmentChoices/InvestorNewsNewsletter/p036753

A Shocking New Morningstar Study!

Gary D. Halbert — Tue, 24 Jun 2008 19:06:00 GMT

IN THIS ISSUE:

A Shocking (To Some) Morningstar Report
What’s The Big Deal?
Other Important Questions To Ask
Do It Yourself Or Let Us Help You

Introduction

There is little doubt that the Morningstar organization has been very good to the mutual fund industry. Morningstar is by far the most widely followed mutual fund performance reporting database. Since 1984, Morningstar has offered data collection and analysis tools to aid investors ranging from industry professionals to do-it-yourselfers. However, some in the mutual fund industry may now be thinking that Morningstar has stopped helping and started meddling.

Why? Morningstar released a study last week showing that many mutual fund managers have little or none of their own money in the very funds they manage. Russel Kinnel, director of fund research at Morningstar, noted that the new study “…was the first comprehensive look at fund ownership among the some 6,000 funds in the firm’s database.” And what they found wasn’t pretty.

I’ll get into the details of the new Morningstar report later on in the E-Letter, but suffice it to say that there’s a very good chance that your mutual fund managers aren’t depending upon their own skills for financial success, though they expect you to do so. The Investment News called it an indication that many fund managers live by a philosophy of “invest as I say, not as I do.”

While there is certainly no legal requirement that mutual fund managers invest in their own funds, I think investors have a right to expect money managers to be invested right alongside them. I certainly do! I think this is especially true in light of some of the black eyes Wall Street has been given over the last decade or so.

This week, I’m going to delve deeper into the recently released Morningstar study, and provide some figures that may shock you. Plus, I will tell you why I think it’s very important that your money manager be invested alongside you, with his/her own money on the line – and not just a token investment. Plus, I’ll highlight other information that you may not know about a money manager unless you ask the right questions. This information is important for you to know, no matter what kind of investor you are.

Finally, be sure to read the “P.S.” at the end wherein I address a good question that many of you have raised about Scotia Partners and their red-hot performance record.

The Surprising Morningstar Study

On June 16, Morningstar, Inc. released a new study that evaluated how much money mutual fund managers have invested in the funds they manage. Since 2005, the Securities and Exchange Commission (SEC) has required mutual fund companies to disclose how much money fund managers have in the funds they manage.

Accessing manager investment information is not difficult. As a general rule, you can find it in the fund’s “Statement of Additional Information” (SAI), which is usually available either in printed form accompanying a fund’s prospectus or on a fund’s website. If you can’t locate the information in either of these two places, ask the fund’s sponsor to provide it to you.

I would think most investors assume that their mutual fund manager had a sizable amount of his/her own money in the fund(s) they manage. I certainly do; in fact, I have the bulk of my non-cash assets invested in the products I recommend.

Yet the new Morningstar study shows that about half of the mutual fund managers they track have NONE of their own money in the funds they manage. ZERO.

Morningstar found that 47% of US stock funds and 61% of foreign stock funds have no investment of the manager’s own money. Bond funds fare even worse with 66% of taxable bond funds, 71% of balanced funds and 80% of municipal bond funds having no manager investment.

Morningstar’s report offers only a few legitimate excuses for fund managers not to invest in their own funds. These might include “index” funds, “target-date” funds that do not meet the manager’s time horizon, single-state municipal bond funds where the fund manager lives in another state and situations where the manager is a foreign national from a country that bars investment in US funds. Those possible exceptions aside, I find it hard to imagine a mutual fund objective that couldn’t merit at least a small allocation of the fund manager’s own money, many of whom earn millions of dollars per year in management fees.

Perhaps the most interesting part of the study was Morningstar’s analysis of its own “Picks and Pans.” This is a service provided by Morningstar where they select funds that may be good long-term investments (the “Picks”) as well as mutual funds to avoid (the “Pans”). When analyzing management investment in these two groups, Morningstar found that the Picks had a median manager investment of $430,000, whereas the median investment by the fund managers in the Pan category was $0. On average, the Picks had seven times the manager investment than the Pans. Get the message?

While Morningstar is quick to point out that the lack of a manager’s investment does not necessarily doom a fund to poor performance, it certainly doesn’t do anything to help an investor’s confidence in the fund. I think this is especially true in light of recent shenanigans in the financial services industry such as last year’s subprime crisis and the mutual fund scandals just five years ago. Sadly, each of these crises highlighted events where personal self-interest outweighed the duty to put clients’ interests first.

Let me be quick to clarify that I’m not trying to equate managers who don’t invest in their own funds to those responsible for the subprime debacle and mutual fund scandals, but I do think it shows a sense of arrogance on the part of many mutual fund insiders that they expect investors to put money into funds that they won’t even invest in themselves.

Gary D. Halbert, ProFutures, Inc. and Halbert Wealth Management, Inc. are not affiliated with nor do they endorse, sponsor or recommend the following product or service.

The Importance of Personal Investment

Some in the investment world and financial press were shocked at the revelations of the Morningstar study, but not me. After evaluating money managers for over 30 years, it’s hard to be shocked by anything I might uncover. It has not been uncommon for me to come across professional money managers who do not invest in their own programs. Fortunately, I can also attest to the fact that there are many money managers who do put their clients first and do invest alongside them in the funds and programs they manage.

As noted above, I invest my own money in all of the programs my company recommends, which I feel is important. You should also know that I require the money managers that we recommend to “eat their own cooking.” The way I see it, if a money manager’s program isn’t good enough for his/her own money, then it’s certainly not good enough for you or me.

Simply put, if I am going to entrust my clients’ money, and my own money, to an Advisor, I want to know they have a significant percentage of their own money in their programs. If an Advisor doesn’t have his own money in his program, I consider that to be a major red flag.

Interestingly, most of the successful Advisors I have met do have a huge amount of their own money invested in their programs – sometimes even more than they should. When you read over some of the bios of our recommended Advisors, you will find that several of them got into the money management business primarily to manage their own money after retiring from another profession or selling a business.

Upon receiving large payouts, they could not find acceptable money managers for their nest eggs, so they decided to do it themselves. Thus, some of the managers I recommend only started managing money for outside investors after they devised a successful system for managing their own money.

On a more basic level, having both the Advisor and myself investing significant portions of our net worth alongside our clients shows our confidence in the programs we offer. The last question I always ask myself when considering a new Advisor is whether I want to invest my own money in his or her program. If the answer is yes, then we move ahead. If not, then you’ll never see that program on our list of recommended Advisors.

Conclusions

The recent Morningstar study revelations come as just more bad news about the actions and attitude of some players at the highest levels in the financial services industry. I suspect that the publication of this report will cause many fund managers to invest in their own funds, but for the wrong reason. I’d rather have a manager invest because he has confidence in his or her own abilities, rather than just to get off of Morningstar’s list.

Though the issue of whether or not money managers invest in their own programs is important, it’s not the only issue that needs to be addressed when evaluating professional money managers. The additional due diligence considerations I discussed above should give you a pretty good idea of what it takes to evaluate mutual fund managers, RIAs, managed account Advisors and hedge fund managers. Now all you have to do is apply these principles to the various investment alternatives you may be considering.

Unfortunately, most investors never take the time to ask even a fraction of the questions necessary to get the information discussed in this article. Most also have no desire to travel all over the country and conduct this type of intense due diligence. Even if they did, most investors are not equipped to evaluate the answers given to many of the questions discussed above or the operations of funds and Advisors.

The good news is that my company already has the staff, expertise, experience and the annual budget necessary to search for successful money managers and engage in the due diligence process on behalf of our clients. We also have the necessary hardware, software and database applications to be able to monitor performance on a daily basis as well as identify new prospective Advisors.

And remember that I have my own money invested with every Advisor and program we recommend. That’s how we monitor them on a daily basis.

If you are interested in the programs I recommend, give one of our Investment Consultants a call at 800-348-3601. You may also contact us via e-mail at info@halbertwealth.com. You can also visit our website at www.halbertwealth.com to learn about the kinds of investment programs we offer.

Wishing you profits,

Gary D. Halbert

P.S. – Two weeks ago, I told you about an exciting new investment program from Scotia Partners, Ltd. that has shown the ability to thrive in the market’s recent high volatility. Many of you have called or completed our online information request to get more information about this impressive program. Some of our clients, however, have expressed a concern about investing after a 90%+ run-up in performance over the past 12 months, thinking that the program may be ripe for a retreat.

Actually, this is a very legitimate concern and one that we have considered as well. However, it is important to remember that Scotia’s trading model only seeks to be in the market on those days with the highest probability of success, and has historically been in the money market account apprx. 65% of the time. While there’s no guarantee that the Growth S&P Plus Strategy won’t pull back after this period of impressive performance, we think the more likely scenario is that the model may spend more time in the money market fund.

The Scotia Growth S&P Plus Strategy has gained apprx. 9.8% so far in June as of yesterday’s (June 21) market close. When this monthly gain is factored in with its May 31 year-to-date gain of 32.56%, the program is now up over 45% for the year. While past performance may not be indicative of future results, I think the Growth S&P Plus program deserves consideration as an aggressive part of your overall portfolio. Before making a decision to invest, be sure to read the Important Notes following the Special Articles. Click HERE to read my June 10 E-Letter introducing Scotia Partners.

IMPORTANT NOTES:

Historical performance data represents an actual account in a program named Scotia Partners Growth S&P Plus, custodied at Rydex Series Trust, and verified by Theta Investment Research, LLC. Estimate for mid-June 2008 is from the Theta tracking account. Since all accounts in the program are managed similarly, the results shown are representative of the majority of participants in the Scotia Partners Growth S&P Plus. The signals are generated by the use of a proprietary model developed by Scotia Partners. Statistics for “Worst Drawdown” are calculated as of month-end. Drawdowns within a month may have been greater. PAST RESULTS ARE NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. Mutual funds carry their own expenses which are outlined in the fund’s prospectus. An account with any Advisor is not a bank account and is not guaranteed by FDIC or any other governmental agency.

In addition, you should be aware that (i) the Scotia Partners Growth S&P Plus program is speculative and involves a high degree of risk; (ii) the Scotia Partners trading program’s performance may be volatile; (iii) an investor could lose all or a substantial amount of his or her investment in the program; (iv) Purcell Advisory Services will have trading authority over an investor’s account and the use of a single advisor could mean lack of diversification and consequently higher risk; and (v) the Purcell Advisory Services trading program’s fees and expenses (if any) will reduce an investor’s trading profits, or increase any trading losses.

Investing During Retirement

Gary D. Halbert — Tue, 27 May 2008 20:37:12 GMT

By: Mike Posey

IN THIS ISSUE:

Risk Considerations In A Retirement Portfolio
No Shortage Of Investment Options
Immediate Annuities
Fixed-Income Alternatives

Introduction

We're now in the home stretch in this series of Retirement Focus E-Letters dedicated to converting your nest egg into a retirement income stream. Over the past year or so, I have written about how to determine how much might be enough to fund your retirement, as well as how to determine the best way to convert your nest egg into an income stream during your golden years.

As I promised in my March 18 Retirement Focus E-Letter, this week I'm going to address the issue of how to invest your money after retirement. We'll cover the importance of risk management during retirement as well as various ways to invest to produce the income you need. In the end, we'll discover that post-retirement investing is a delicate balance of risk and reward that must be achieved in order to reach your goal of a secure retirement.

Before launching into this week's topic, I want to be sure to remind you that any investment information provided in this E-Letter is general in nature, and should not be construed as investment advice. You should always evaluate investment options in light of your personal financial situation, retirement goals and any special circumstances you may have. Ideally, you should consult a qualified investment professional who can take the time to review your situation and tailor an investment approach to meet your needs.

Revisiting Gary's Risk Discussion

Gary did a great job in his April 22 E-Letter that highlighted both common and lesser-known risks associated with investing. His risk analysis discussion is especially important for those who are investing during retirement, since the negative consequences of taking on too much investment risk can be far greater during retirement than while accumulating a nest egg.

Just one example of a retirement portfolio's heightened sensitivity to risk is the issue of investment losses in the early years of retirement. To illustrate, let's use real-life historical market data to show the effects of early market losses. An investor retires on December 31, 1999 with a nest egg of $500,000, and decides to take 6% annual withdrawals. To keep it simple, we'll assume he decides to invest it in an S&P 500 Index fund, lured by that Index's phenomenal returns (33.36% in 1997, 28.58% in 1998 and 21.04% in 1999) just prior to retirement. The following table tells the story of this investor's first three years in retirement:

Year	Beginning Balance	Income Distribution	Investment Gain/Loss	Ending Balance
2000	$500,000	$30,000	( 9.11%)	$427,183
2001	$427,183	$25,631	(11.88%)	$353,848
2002	$353,848	$21,231	(22.10%)	$259,109

Note that with the December 31, 2002 balance of $259,109, the January 2003 distribution would be only $15,547, or roughly half of the original amount of income at the beginning of retirement - all in the space of just three years.

Recalling Gary's discussion about the amount of return required to break even, we find that it will take a total return of 93% just for this investor to get back to even, which will be especially hard to do considering an automatic 6% withdrawal each year.

The moral of this story is that the combination of steady withdrawals and portfolio losses can send a retirement portfolio's value into a downward spiral from which it might never recover, resulting in you possibly running out of money later in life, or reducing the level of income below what is needed for a comfortable retirement. Granted, the above example chooses three of the worst years on record for the stock markets, but how do we know that the next three years won't be a repeat of 2000 - 2002 in the stock market? The answer is that we don't, so retirees must invest with an eye on risk management.

The remainder of this article will address the various ways to invest during retirement. Over the course of this discussion, the guiding principle will be to balance the various investment risks such that you will have both a meaningful level of income, but also avoid running out of money in retirement.

Retirement Investing - No Shortage Of Options

With the oldest of the Baby Boomers now eligible for Social Security early retirement, mutual funds, brokerage firms, insurance companies and the like have all come out with a variety of products designed to fill the need for retirement income. Accompanying this deluge of products are reams of articles dedicated to advising both investors and investment professionals on how to position their retirement portfolios for optimum income and longevity. As if this glut of frequently conflicting advice isn't bad enough, add in a generous helping of warnings from regulatory agencies regarding scams and bogus investments aimed at seniors, and you get what Gary likes to call "information overload."

My goal in this and subsequent E-Letters in this series will be to acquaint you with a variety of alternatives for post-retirement investing. Be aware, however, that there is no possible way that I can provide information about every conceivable way to invest for retirement. Nor can I launch into very detailed explanations of the products and investment strategies I do cover, since I am restricted as to space in these E-Letters. Even so, my hope is that I can provide you with a basic knowledge of how each of these options works.

With those caveats aside, it's time to delve into ways you might want to invest during the course of your retirement. As a general rule, I categorize the various post-retirement investment strategies into the following six broad categories:

Immediate Annuities - This is perhaps the simplest alternative in that it requires only one decision at the beginning of retirement. While I will discuss other annuity contracts below, an immediate annuity is different in that its sole purpose is to make periodic payments of income over the lifetime of the policyholder.
Fixed Income Alternatives - This type of investment includes bank certificates of deposit as well as insurance company fixed annuities. It can also include individual bonds purchased to hold to maturity. The key characteristic of this group is that the initial and renewal interest rates are fixed by the issuer for a period of time. For individual bonds, and CDs, the interest rate may be set until the bond's maturity, while fixed annuities often have annual interest rate resets.
Variable Annuities - In addition to fixed annuities, the insurance industry has a whole host of variable annuity contracts. Variable annuities differ from fixed contracts in that the value of the annuity will vary based on the performance of the markets. Some have referred to variable annuities as a "mutual fund in an insurance wrapper," and this is a pretty accurate description. However, there are some major differences between mutual funds and variable annuities, which I will discuss in more detail later on.
Asset Allocation Alternatives - This is by far the largest category of investment alternatives, in that asset allocation strategies can range from single-product mutual fund purchases to individually tailored investment allocations provided by a financial professional. The key in any asset allocation program is to diversify the portfolio in such a way as to balance the risk and reward of investing in light of an investor's goals, risk tolerance and investment horizon.
Actively Managed Strategies - Actively managed strategies are similar to the asset allocation option in that a variety of securities are purchased with the overall goal of producing a retirement income. However, actively managed strategies differ in that these programs are not passive buy-and-hold portfolios. Instead, an active manager will generally seek to position investments in markets that they believe have the greatest potential for gain, and if markets are down or uncertain, the active manager may retreat to cash or even hedge long positions.
Other Alternatives - Within this catch-all category, I would place real estate (both direct investments and REITs) as well as other income-producing alternatives that you might not otherwise consider.

Due to space limitations, I'll only be able to cover a couple of the above categories this week, with the remainder being covered in future Retirement Focus issues. As I discuss these various options, I will include some links to additional information on these investment options.

Immediate Annuities

One of the major risks that retirees face is the possibility of outliving their money. With fewer and fewer people being covered by defined benefit plans that can provide an income for life, the onus is being placed upon the individual retirees to make sure post-retirement investments are such that their money will not run out.

The immediate annuity contract addresses the risk of outliving your money by providing a periodic retirement check as long as you live. There are even options available that provide an income for as long as you live, plus provide the same or a lesser amount to a surviving spouse as long as they live. Most immediate annuity contracts are "fixed," in that they provide an assumed level of return, but there are also variable immediate annuities, as I will discuss later on.

In fixed immediate annuity contracts, once the annuity is purchased, the amount of periodic income is set and will not vary in the future. However, there are some fixed contracts being introduced that will provide for an increasing payment over time, as well as variable immediate annuities where the periodic payment varies with the investment performance.

The biggest advantage of these contracts is that the payments continue for life, even if your premium plus earnings would have otherwise been exhausted. The insurance company takes on the risk that you will live longer than your actuarial life expectancy, while you take on the risks of dying early and your heirs losing access to the premium paid.

I wrote about the basics of an annuity payout in my July 24, 2007 E-Letter, along with the major advantages and disadvantages. Rather than trying to summarize all of that material in this E-Letter, I encourage you to go back and read the Annuity Payout E-Letter to get up to speed on this investment option.

I do want to address several issues in regard to this method of providing retirement income. First, it is important to remember that in most immediate annuity contracts, you cannot change your mind several years later and receive a distribution of the remaining value. This is why most Advisors counsel retirees to not put their entire nest eggs into immediate annuities, since doing so could leave them without resources in case of an emergency expense.

The insurance industry is developing new immediate annuity products that address this illiquidity, but any flexibility comes at a cost. Some immediate annuity contracts do allow limited withdrawals, but periodic payments may be reduced to compensate for this extra benefit. Others allow withdrawals only during the early years of the contract, but charge a surrender fee if this option is exercised.

A second risk when purchasing an immediate annuity is dying prior to reaching life expectancy, and especially during the early years of the contract. In a life-only payout, all payments would cease and any windfall would go to the insurance company. For this reason, annuity companies provide optional forms of payments such as period-certain, joint-and-survivor and installment refund options that can extend beyond the annuitant's life span should an early death occur. These alternative forms of payment, however, do come at the cost of lower periodic payments.

Since the payout from a fixed immediate annuity is set over the lifetime of the annuitant, another possible disadvantage is the loss of purchasing power. According to the actuaries, a retiree at age 65 can expect to live around 18 more years. However, it is not uncommon to see people live far beyond that point. While the insurance company guarantees to pay an income for the life of the individual, they cannot guarantee that its buying power will remain the same.

In other words, inflation is the natural enemy of the fixed immediate annuity. Using the Department of Labor's inflation calculator, we can see that a $1,000 payout in 1988 would have the purchasing power of only about $550 today, while the same payout beginning in 1978 would have the buying power of only $303 after 30 years of inflation had taken its toll. If future inflation trends are similar to those of the past 30 years, an annuitant could see his or her buying power halved in 20 years, and cut to a third in 30 years.

The insurance industry has also addressed this disadvantage by providing a variable immediate annuity. Like the fixed immediate annuity, the variable contract provides an income for life. However, unlike its fixed counterpart, payments from the variable immediate annuity can rise or fall based on the performance of a portfolio of investments.

It works like this - the annuitant buys a variable immediate annuity from an insurance company and the initial monthly payment is calculated using an assumed rate of investment return. After that, the monthly payment will be based on the performance of the investment portfolio chosen by the annuitant.

If the investments do well, then payments can rise over time and possibly overcome the effects of inflation. However, the annuitant also takes on market risk so that if the selected investments do poorly, the income payments will fall, possibly below what a fixed contract would have paid. Some companies do provide a guarantee that payments cannot fall below 80% to 85% of the initial payout, but this comes at the cost of higher expense charges.

Just as with any other investment alternatives, fixed and variable immediate annuities are just one tool that can be used to provide retirement income. The important thing to remember is that the guarantee of an income for life depends upon the strength of the company issuing the annuity contract. Therefore, you should only place your money with an insurance company that you feel is safe, solid and will be around 30 years from now.

To assist you in your evaluation process, I recommend that you check out a prospective insurance company's ratings with at least one of the five major insurance company rating services (Moody's, A.M. Best Company, Weiss Research, Standard & Poor's and Duff & Phelps). A link to all of these ratings services can be found at the Insbuyer.com website at the following web address: http://www.insbuyer.com/insurancenrating.htm.

You can also obtain quotes on how much monthly income your nest egg will purchase under various annuity options on many Internet websites. You can find these websites by typing "immediate annuity quote" into an Internet search engine. One I have found to be helpful is at http://www.immediateannuities.com. Note that these guides are useful to get a general idea of what annuity income may be available, but you should always consult a qualified insurance professional before buying any annuity contract.

Fixed Income Alternatives

As noted above, the fixed income category covers a lot of different types of investments, and is characterized by paying a fixed or stated rate of return for a specific period of time. In some fixed income investments, the fixed rate of return may span from several months to many years. In others, such as a fixed deferred annuity contract, the interest rate may be revised annually.

Fixed income investments can also be subject to a wide range of tax treatment on the income produced by the investment, such as municipal bonds where interest is generally income tax free, to fixed deferred annuity contracts where taxation is deferred until withdrawn from the contract. For a more detailed discussion of tax considerations, see my November 13, 2007 E-Letter.

Because the category of fixed income includes CDs and fixed annuities, many investors think that only low-return investments are included. While it's true that some fixed income investments do have low returns, there are others that have the potential for very attractive returns, even to investors that primarily invest in equities. Of course, with this increased return potential comes a generous helping of increased risks as well.

A major advantage of fixed income investments is that they are generally not highly correlated with equity investments. As a result, including certain types of fixed income investments in a diversified retirement portfolio can lower a portfolio's volatility, and sometimes even offset losses in the equity portion of the portfolio. While the major thrust of this article is the production of income from fixed income investments, this non-correlation can be just as beneficial after retirement as it is in the accumulation phase. As a general rule, the category of fixed income investments usually includes the following types of investments:

Certificates of Deposit (CDs) - This category is very familiar as most people have had a CD at one time in their life or another. The CD may be one offered by your local bank, or can be a CD offered by a local broker. These "brokered CDs" often have higher rates of return than those of your local bank, so they are worth checking out. All are fully insured by the FDIC up to the maximum amount permitted by law and, as a result, usually have a very modest return. Interest can accumulate in the CD, or be withdrawn monthly to provide retirement income.

A relatively new type of CD known as an "equity-indexed CD" can provide a higher rate of return based on the appreciation of a stock index such as the S&P 500 Index. However, these CDs usually require that you lock in your investment for a period of five or more years, and do not usually provide for interest payments during this time. Thus, they may be of limited use for retirees who need current income from their investments. You can learn more about this innovative form of CD at the following website: http://www.sec.gov/answers/equitylinkedcds.htm.

As with bonds that I will discuss below, the most common way to invest in CDs for retirement is by "laddering" the maturity dates. I discussed this process in my December 11, 2007 E-Letter, so I won't repeat it here. One good place to check for the going rate of return on various types of CDs is on the Bankrate.com website at http://www.bankrate.com/brm/rate/deposits_home.asp.
Fixed Deferred Annuity Contracts - I discussed fixed immediate annuities above, but a "fixed deferred" annuity contract is sometimes used as a low-risk investment that may have a little higher annual return than a CD, as well as offer more flexibility than an immediate annuity. While fixed deferred annuities are usually built for the accumulation phase before retirement, they can also be used during retirement by withdrawing interest and principal as needed.

However, be aware that fixed deferred annuity contracts often have a surrender charge if you change your mind and want to invest elsewhere. Periodic partial distributions often escape this surrender charge, but it's something you want to ask about before you invest. As with an immediate annuity, the safety of your investment depends on the strength of the issuing company. Therefore, do your homework before investing.

In addition, fixed deferred annuities will sometimes offer a high "bonus" rate of return in the early years to provide an incentive for you to invest. However, you will want to ask the issuing insurance company for a copy of their renewal rate history to see how you might fare after the bonus period has ended. This renewal rate can never go below a minimum guaranteed rate of interest, but this guaranteed rate is often very low.

A very specialized form of fixed deferred annuity is known as the "equity-indexed annuity," in which you can participate in a particular stock market index's gain, but be guaranteed to not lose any money if the market goes down. Since this investment usually requires that you lock up your money for some period of time, I won't discuss this option since this type of annuity is not used for generating monthly income. However, I plan to do a future E-Letter on this very interesting type of fixed deferred annuity.

Annuity contracts are sometimes seen as a beneficial investment for risk-averse investors since they offer a minimum guaranteed rate of interest, provided that the insurance carrier you select is stable and solid. However, while Consumer Reports (CRMA) had high praise for immediate annuities, they did not share the same opinion of fixed immediate annuities. They said:

CRMA experts found that even with all the tax advantages, annuities are usually poor investments. They come with lofty fees and stiff withdrawal penalties. If you invest with a shaky insurer that goes out of business and you have a fixed-rate annuity, the state only guarantees that you will get some of your investment back.

You can get more information about annuities on the Internet at the Annuity Buyer's Guide website at http://www.annuitybuyersguide.com/what-is-an-annuity-.html.
Bonds - This category includes a wide variety of debt instruments and can range from Treasury notes and bonds to high-yield corporate issues. This investment process may involve purchasing individual bonds rather than investing in bond mutual funds. As a general rule, the longer the maturity of the bond, the higher the interest paid.

Perhaps the bond most interesting to retirees is the municipal bond, which can escape federal income taxation in most cases. As a result, the interest rate on these bonds is usually lower than in similar taxable bonds. Thus, the value of tax deferral depends upon your tax bracket, since a low tax bracket may not merit the reduced interest rate. It is also important to note that tax-exempt interest from municipal bonds is added back for purposes of determining how much of your Social Security benefit may be taxable, so remember this if you choose to invest in this type of investment.

Obviously, the greater the security of the bond, the lower the interest rate will be. Thus, Treasury bonds secured by the full faith and credit of the US government are considered to be the safest. There are even Treasury Inflation Protected Securities (TIPS) that are not only backed by the US government, but also adjust their return for inflation.

At the other end of the spectrum are high-yield corporate bonds, which are also called "junk bonds," and for a good reason. High-yield bonds are issued by companies with less than stellar prospects for the future. Thus, there is not only no guarantee they will be paid upon maturity, but the company may not even survive to pay the interest. However, some retirees with smaller portfolios may be attracted to these bonds since they provide a higher level of income than other options. Just remember that this high level of income comes with substantially higher risk.

As I noted above in regard to CDs, the most common form of investment in bonds during retirement should involve "laddering" the maturity dates so that you have periodic liquidity. This also serves to make sure that you get the advantage of both short-term liquidity and the generally higher interest rates on long-term maturities. Another advantage of using individual bonds to fund retirement is that you can build a ladder of various types of bonds, both government and corporate, to provide additional diversification.

Another important thing to remember when investing in bonds is that the market values of the bonds may fluctuate over time with prevailing interest rates. As a general rule, when interest rates go higher, bond prices go lower. This could cause retirees some concern when they get brokerage statements showing that their nest egg has lost value. However, laddering strategies usually provide for keeping the bonds until maturity, at which time they will pay full par value. Thus, don't let periodic market dips concern you as long as you have planned to hold on to maturity.
Unit Investment Trusts (UITs) - This is a specialized type of investment offered by brokerage firms that consists of a portfolio of similar securities held for a specified time and usually pays a pre-determined rate of return for the duration of the trust. While many UITs are set up to invest in a portfolio of bonds, there are some that also include stocks. UITs are considered to be buy-and-hold investments with a fixed maturity, and interest income from the portfolio is paid periodically to shareholders, making them attractive to retirees.

Principal is returned to the investor upon maturity of the trust. Since most UITs invest in bonds that pay their par value upon maturity, there is generally little principal risk in these investments. Of course, this is not the case with any UIT that contains stocks. Loss of principal may also occur if an investor liquidates units prior to maturity.

While a UIT is similar to a mutual fund, it differs in that once the portfolio of securities is selected, there is no active management of assets. As a result, operating expenses of UITs are often lower than actively managed bond mutual funds. UITs are generally seen as a low-risk, low-return form of investing, but may be appropriate for a portion of your retirement money. Be aware, however, that up-front sales loads can be considerable in UITs, so compare returns net of these expenses to other alternatives before investing. You can learn more about UITs at the following website sponsored by the SEC: http://www.sec.gov/answers/uit.htm.

There are other types of fixed income investments not covered above such as US savings bonds, money market mutual funds, convertible bonds, zero-coupon bonds, and the now infamous mortgage-backed securities, among others. There are also bond mutual funds for virtually all types of debt instruments that provide many of the same advantages of buying individual bonds, but relieve the investor of having to decide which bonds to buy. The key to including any fixed income investment in a post-retirement portfolio is usually the ability to have a safe, stable amount of income with at least some measure of principal protection.

That's it for this week. In my next Retirement Focus issue, I'll continue discussing the various ways to invest for retirement. Until then, if you have any questions about the options given above, or would like me to cover a specific investment option, please feel free to contact me at info@halbertwealth.com.

Best regards,

Mike Posey

SPECIAL ARTICLES

Boomers' Eagerness to Retire Could Cost Them
http://www.usatoday.com/money/perfi/retirement/2008-01-13-turning-62-cover_N.htm

The Oil Speculation Debate
http://calculatedrisk.blogspot.com/2008/05/oil-speculation-debate.html

No Clear Map for Clinton's Political Future
http://www.washingtonpost.com/wp-dyn/content/article/2008/05/26/AR2008052602006.html

Retirement Focus - Pros & Cons of Annuity Payouts

Gary D. Halbert — Tue, 24 Jul 2007 09:33:00 GMT

IN THIS ISSUE: 1. Overview Of Retirement Plan Distributions 2. Types Of Annuity Payouts 3. Advanced Annuity Payout Concepts 4. Retirement Tidbit - Minimum Distributions Introduction As I noted in my last Retirement Focus feature back on June 5 , one of...(read more)

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Retirement Focus - Year-End Retirement Sugarplums

Introduction

Mandatory IRA Distributions

Charitable Donations From An IRA

Roth IRA Conversions

Max Out 401(k) contributions

Plan Your Investment Strategy

Conclusions and Happy Holidays

"Gifting" & Things To Be Thankful For This Holiday

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Gifting To Those You Love

Gifting: Control Is The Issue

Gifting To Adult Children

A Good Gifting Strategy, In My Opinion

A Time For Giving Thanks

Thanks For Long-Distance Relationships

Thanking Those Close To Home

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The Bottom Line On Market Timing

A Market Timer That Works

A Scotia Program For Less Aggressive Investors

Conclusions

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Variable Deferred Annuities

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Retirement Tidbit – Making The Most Of Retirement

Conclusion

A Shocking New Morningstar Study!

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The Surprising Morningstar Study

The Importance of Personal Investment

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Investing During Retirement

Introduction

Revisiting Gary's Risk Discussion

Retirement Investing - No Shortage Of Options

Immediate Annuities

Fixed Income Alternatives

Retirement Focus - Pros & Cons of Annuity Payouts