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Rational Investing

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by Clark Davis

(This is the fourth in a series based on our most requested presentation, PRIMED for Success: Rational Investing In Irrational Markets.)

Many people looking forward to retirement have a real concern about not having enough money to last them the rest of their lives. It is a natural concern, most often born of the fear of health costs, inflation and emergencies.

It is not uncommon for a new retiree to become penurious, sometimes to the point of absurdity. (One couple we knew several years ago would go to a two-for-the-price-of-one sandwich special at a local fast food place, share one of the sandwiches at lunch, and take the second home to split for dinner; this in spite of their having a net worth of more than $800,000.)

Frequently a retiree will erroneously perceive a retirement fund shortfall because of a lifetime of misconception resulting from investment and insurance industry sales efforts that have emphasized retiring on your investment and savings income in other words, not using any of your principal.

We suggest that you avoid this very restrictive and potentially disastrous advice by not thinking in terms of income, but rather of cash flow and defining the word principal as meaning your beginning principal.

This allows you to be realistic about using some of the investment gains (appreciation) you should realize from your investments. By doing so you can also lower your tax liability, thus increasing your spendable cash.

Think of it this way. The tax rate on your dividends and interest could be as much as twice the tax rate for long-term capital gains. That is not a small difference, and one you should discuss with your CPA when you are doing your tax and retirement planning.

Note that this technique of using cash flow (a combination of dividends, interest and capital gains) instead of interest only will not work effectively if you invest solely in fixed-income investments.

For example, there is no possibility of your principal growing in a certificate of deposit. The certificate of deposit increases in value only if you reinvest your interest, but cannot provide any inflation protection in the form of appreciation of your beginning principal. (Your banker knows this. Guess where he has more of his money, in certificates of deposit or in stocks?)

The same holds for bonds, unless you invest in very large positions (a round lot is generally considered $1 million) and are able to take advantage of interest rate fluctuations by "trading" the bonds on such fluctuations.

Another conditioned response is one of retiring and immediately starting withdrawal of monies accumulated in retirement accounts. In most cases in which you are eligible to leave monies in tax-deferred retirement accounts (IRA, IRA rollovers, etc.) it is best to let those funds remain there as long as possible.

After all, they are growing tax-deferred, but when you take them out you pay taxes on the amounts you withdraw. If your circumstances allow, it is better to leave such tax-deferred assets in the accounts and use the income and principal from taxable accounts first, even to the point of using up the principal.

This is a concept that is anathema to many who have been encouraged to think in terms of immediately starting to withdraw their retirement assets.

Because of the various rules concerning age, mandatory withdrawals, withdrawal rates, estate and income taxes, etc., we again suggest that you work with a professional knowledgeable in these areas.

Remember, there is no one simple answer that will fit every situation, so resist the advice given by those who tell you what you should do without spending the time to examine all the ramifications of your options.

My suggestion? Stick with a CPA who is qualified in financial and retirement planning.

The next column will explore investment rates of return relative to your risk tolerance, or, as we prefer to think of it, your comfort level.

(Clark Davis is a 30-year investment veteran and CEO of Saint Louis Investment Advisors, a specialized money management company. Questions or comments can be directed to him by mail via The Springfield Business Journal, 313 Park Central West 65806 or by e-mail at clark@slia.com.)

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