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Sunday, February 8, 2009

How to Invest Your IRA Under an Obama Presidency

By Charles L. Stanley CFP ChFC AIF

Whether you are an Obama fan or an Obama opponent, since he has become our newest President of the United States his policies will have an affect on the financial markets, both domestically and internationally. He wants to bring change to the United States which by extension means world markets because we have such a huge economic foot print.

With Barak Obama as President and the most powerful leader in the world, how should you structure your investment portfolio - both your taxable portfolio and your 401(k) or IRA, etc.?

1. Taxes will matter: We still don't have the details of how the tax code will be changed, but indications have been that at least some of the population (which targets the investing population) will see an increase in taxes on dividends and capital gains. If, for example, you pay a 20% or 25% rate of tax on capital gains instead of a 15% (or less), it is clear that there will be less money to reinvest or to live on after taxes are paid. Dividend rated could go up as high as 35% which will really kill the benefit of dividend paying stocks and bonds. So, you may want to consider the incorporation of tax free municipal bonds (but then with municipalities gong broke, be sure you look before your leap). Discuss tax management with your Advisor on the rest of your portfolio. Tax managed passive mutual funds have an extremely low tax impact.

2. You can't fool Mother Nature or the Capital Markets, they work: Turn on your TV any week-end and you will hear the "gurus" announcing which sectors or industries will boom under the Obama Administration and which will go bust. Academicians have shown over and again that such attempts to combine stock picking with market timing almost never outperform the broad market - the truth is they generally underperform. When they do outperform it is usually just plain luck rather than skill that can be exploited for profits and this it is not repeatable. Financial markets are essentially efficient and any attempt to regulate trade or change tax policy will end up being priced into the securities as soon as the news hits the wires.

3. Remove uncertainty by Diversification: Risk is really the uncertainty of future outcomes when investing. Diversification will reduce the uncertainty of a given portfolio. Lets assume you have a fund with 3500 stocks in it. A couple of those happen to be Bear Stearns and Lehman Brothers. With that many companies in your portfolio, you will hardly notice it as those two companies go out of existence. On the other hand, if you have a mutual fund of only financial companies, you will feel it big time. See what I mean? You can reduce the risk of uncertainty through very broad diversification.

4. Risk and Return are Related: Exposure to meaningful risk factors in a diversified portfolio determines expected return. Over the long haul, stocks outperform bonds but not always; over the long haul small stocks outperform large stocks, but not always; over the long haul value stocks outperform growth stocks, but not always. Each of these outperformers has a greater volatility risk and a greater expected return.

5. Portfolio Structure Explains Performance: Asset allocation along size, value, and market exposure dimensions primarily determines the results of a broadly diversified portfolio. In other words, to increase the expected return of your portfolio under an Obama Presidency, own low cost, globally diversified asset class mutual funds that are over weighted to smaller and more value oriented stocks. If an all stock fund portfolio is too volatile for you, add some short term bond funds to damper the volatility.

Following academically sound investment principles will allow you to win the losers game during an Obama Presidency. Dont give in to the Wall Street marketing gurus who have proven their ability to separate you from your money, quickly and permanently.

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