Rational Investing: Don't follow investment fads, heed sound advice

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Boy, how casual conversations have changed over the course of this year. Last year at this time it was football and dot-coms. This year it is football and ? |ret||ret||tab|

Does any of this sound familiar? |ret||ret||tab|

"I kept reading about the Paradigm Shift' into growth especially technology like the Internet stuff, but that sure hasn't worked." (NASDAQ down 19.4 percent, S&P Barra Growth down 11.9 percent year to date.)|ret||ret||tab|

"My broker has a wall chart that has the annual returns on it going back to 1925. It showed that small company stocks had the best return over the long run, but I got burned by them the last couple of years, so I decided to go with larger company stocks like those in the Dow Jones Industrial Averages." (DJIA are down 7.9 percent year to date.)|ret||ret||tab|

"It doesn't make sense to me. I read an article where John Bogle from Vanguard said to stay with an S&P 500 Index fund. I did and I'm losing money." (Through Oct. 27 the S&P 500 has declined 6.1 percent.) |ret||ret||tab|

"Those NASDAQ commercials on TV talking about the great companies of the future got me all fired up, so I decided to play that index." (NASDAQ is the worst performing of the major indices so far this year a negative 19.4 percent.)|ret||ret||tab|

"Bonds are for old people who want to buy and hold. I want performance." (The Merrill Lynch 10+years Treasury Bond Index through Oct. 26 returned a positive 14.4 percent.)|ret||ret||tab|

"I diversified my investments with several different mutual funds, but they're all down." |ret||ret||tab|

What is going on here?|ret||ret||tab|

Several things, such as fighting the last war (as in buying what was "hot" last year or last quarter.) Having a "hodge-podge" portfolio that isn't consistent with one's risk tolerance. And expecting the well above normal returns of the past four years to continue the "tree grows to the sky" syndrome. |ret||ret||tab|

Even looking at long-term returns averaging 11 percent and believing that average should occur in any given year. Mistakenly thinking one has diversified by acquiring a number of mutual funds without determining if they hold the same issues. |ret||ret||tab|

These are a few of the problems we see when investors ask us to analyze their portfolios. Most of them can be fairly easily corrected by determining the investor's risk tolerance and implementing a portfolio discipline to match that risk tolerance. For many investors it is simply a matter of proper asset allocation a method of investing that is generally misunderstood and frequently misrepresented by the financial community. There is more to it than clicking on a form on a Web site and filling it out or a salesperson asking you what kind of investor you are and then handing you a recommended asset allocation. There are some potential pitfalls that need to be avoided. We'll talk about those in my next column.|ret||ret||tab|

Right now I want to focus on several things to do and a couple to not do between now and the end of the year.|ret||ret||tab|

Do you review with your tax accountant the investment gains and losses you have taken so far this year and evaluate your holdings in terms of minimizing your income tax liability? Don't put it off. Your accountant can help you only if he or she has the necessary information. Once January 1, 2001 is here it's too late.|ret||ret||tab|

Don't let the tax tail wag the investment dog. Take your losses and gains only if the merits of the investments warrant it not just for tax purposes.|ret||ret||tab|

I am not an accounting professional, so before taking any of the following actions you should discuss them with your broker and/or accountant.|ret||ret||tab|

If you want to take a loss in an issue that you feel is a sound long-term holding, there are two ways to do it. You can sell the issue and then, in order to avoid the "wash sale" rule, buy it back in 31 days. An alternative is to double up on the position, hold the new position for at least 31 days and then sell the original position. That avoids being out of the stock should it appreciate. If you use this technique be certain to identify to the broker the tax lot you wish to sell. |ret||ret||tab|

Pay close attention to the holding period of any issues you intend to sell. With short-term gains taxed at ordinary income rates and long term gains taxed at a maximum of 20 percent, note into which category the holding falls. |ret||ret||tab|

Unless you have a very compelling reason to sell immediately, try to convert short-term gains to long-term gains by holding them longer than one year. |ret||ret||tab|

Don't buy any mutual funds between now and year-end unless they have already made their capital gains distribution. This is one of those years in which many mutual funds have taken inordinate gains in chasing quarter by quarter "hot" performance. Buy one of them now and you could get a bad surprise those year-end distributions will be taxed to you even though you may have held the fund for only a few days. Even worse, if the gains are short-term you get nailed at your highest tax rate. Your broker can help you determine distribution dates and amounts for any mutual funds you are considering acquiring.|ret||ret||tab|

|bold_on|(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 sbj@sbj.net.)[[In-content Ad]]