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Rational Investing

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by Clark Davis

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

Before continuing our discussion on rational investing, I want to mention two proposals in Washington that could have a very positive impact on both your personal net worth and the general economy: A change in the holding period for the recognition of long-term capital gains from 18 months to 12 and a lowering of the capital gains rate to 15 percent.

I urge you to write your members of Congress and encourage them to support both measures.

Last issue we discussed the need to identify the purpose for which you are investing. Let's move on to the letter "R," which represents Results, in the acronym PRIMED. What results do you need to accomplish your purpose? How do you quantify that result?

Again, using the vacation analogy of my previous column, our Gulf Shores vacation destination isn't reached just by driving in a southerly direction.

We will know we are there when we have checked into the condo, are sitting on the deck with our feet propped on the railing, sipping a sweet tea (sweety, as they say in those parts) and taking in the view of the seagulls skittering at surf's edge.

So, how do we take the purpose for which we are investing and convert it to dollars? The oft-daunting first step is to determine your net worth and income and expenses. Working with one of the CPAs or investment professionals in Springfield who specialize in financial planning can make this task less painful and much easier.

If you choose to go it alone, ask them for the forms that can be used to compile the information.1 When this step has been completed you will know where you stand.

Now, begin estimating the dollar value of the goal you want to reach. For purposes of this example, let's use a comfortable retirement as the goal. How much will it cost to live in retirement without compromising your lifestyle?

According to recent surveys, people generally find that their living expenses in retirement are approximately 65 percent to 80 percent of their living expenses during their working years. (Note the word living. Items such as expensive hobbies and extensive travel are not included as living expenses. They fall into the categories of travel and entertainment.)

Delete from your current budget those items that will not be expenses in retirement (usually mortgage, transportation to work, employment-required attire, college costs, etc.) and add in the current costs of those that will be retirement-related expenses.

Among the latter may be health care, education, personal travel, entertainment, etc. This becomes your adjusted retirement expense.

Because inflation is a factor in long-term financial planning, its impact on your expenses must be considered. Choose the inflation rate that you believe is the most likely, bearing in mind that the average rate between 1925 and 1997 has been 3 percent.

Using a calculator or interest rate table, apply that rate to your retirement budget for the number of years you have until retirement. (Example: the factor for 3 percent compounding for 15 years is 1.558; thus, if you have 15 years until retirement and your adjusted retirement expenses are currently $40,000, at retirement those expenses can be projected to be approximately $62,320.)

Will your retirement income from all sources cover those expenses?

What sources of income do you have now that will no longer exist in retirement?

What new sources of income will be available in retirement Social Security, savings, investments, distributions from pension, profit sharing or 401(k) plans?

Next column: Will my retirement income be sufficient to meet my expenses or will I have to violate the 11th commandment, Thou Shalt Not Invade Thy Principal?

1. If you are unable to readily obtain the forms, send a stamped, self-addressed envelope to us at 1701 Golfview Drive, Collinsville, IL 62234. Note that we do not do financial planning, but upon request can provide a list of the firms in Springfield that we know offer such services.

(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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